As you approach retirement, one of the most important decisions you'll make is how to handle the distribution of your retirement savings. With the passage of the SECURE 2.0 Act in late 2022, there are several changes and new options to consider when it comes to taking distributions from your 401(k), IRA, or other retirement plans. In this post, we'll explore the key factors to keep in mind and the various distribution choices available to help you make an informed decision.

Understanding Required Minimum Distributions (RMDs)

Required Minimum Distributions (RMDs) are the minimum amounts you must withdraw from your retirement accounts each year, typically starting at age 72 (or 70½ if you reached 70½ before January 1, 2020). The SECURE 2.0 Act has made some notable changes to RMDs:

1. RMD age increase**: The age at which you must start taking RMDs has increased from 72 to 73 in 2023, and it will further increase to 75 in 2033[1].

2. Reduced penalties**: The penalty for failing to take an RMD has been reduced from 50% to 25% of the amount not taken, and if the error is corrected in a timely manner, the penalty may be reduced to 10%[1].

3. Roth 401(k) RMDs eliminated**: Starting in 2024, Roth 401(k) accounts will no longer be subject to RMDs, aligning them with the rules for Roth IRAs[1].

It's crucial to understand how these changes affect your retirement distribution strategy and to ensure that you're taking your RMDs as required to avoid penalties.

Lump Sum vs. Periodic Distributions

One of the primary decisions you'll need to make is whether to take a lump sum distribution or periodic distributions from your retirement accounts. Each option has its pros and cons:

Lump Sum Distribution

A lump sum distribution involves withdrawing your entire retirement account balance in one payment. This option may be appealing if you have immediate financial needs or want to invest the money elsewhere. However, there are some drawbacks to consider:

• Tax implications**: Taking a lump sum distribution can push you into a higher tax bracket, resulting in a larger tax bill in the year you receive the distribution[2].
• Loss of tax-deferred growth**: By withdrawing all your funds at once, you lose the potential for continued tax-deferred growth within the retirement account[2].

Periodic Distributions

Periodic distributions involve taking smaller, regular payments from your retirement account over an extended period. This approach offers several advantages:

• Tax management**: By spreading your distributions over multiple years, you can potentially manage your tax liability and avoid being pushed into a higher tax bracket[2].
• Continued tax-deferred growth**: The funds that remain in your retirement account can continue to grow tax-deferred, potentially providing more income in the long run[2].
• Flexibility**: You can adjust your distribution amount and frequency as your needs change over time[2].

Annuities as a Distribution Option

Another distribution option to consider is purchasing an annuity with a portion of your retirement savings. An annuity is a contract with an insurance company that provides guaranteed income payments for a specified period or for the rest of your life. The SECURE 2.0 Act has made it easier for retirement plans to offer annuities as a distribution option[3].

Annuities can provide several benefits:

• Guaranteed income**: Annuities offer a predictable income stream, which can help alleviate concerns about outliving your savings[3].
• Potential for lifetime income**: Certain types of annuities, such as single premium immediate annuities (SPIAs) or deferred income annuities (DIAs), can provide income for the rest of your life, regardless of how long you live[3].
• Tax-deferred growth**: With a deferred annuity, your money can grow tax-deferred until you start taking distributions[3].

However, annuities also have some drawbacks to consider, such as lack of liquidity, potential surrender charges, and the complexity of some annuity products. It's essential to carefully evaluate your options and consult with a financial professional before purchasing an annuity.

Qualified Charitable Distributions (QCDs)

For those who are charitably inclined, Qualified Charitable Distributions (QCDs) can be a tax-efficient way to support causes you care about while satisfying your RMD requirements. A QCD is a direct transfer of funds from your IRA to a qualified charity. The SECURE 2.0 Act has made some changes to QCDs:

• Increased limit**: The annual QCD limit has increased from $100,000 to $200,000 starting in 2024[4].
• Inflation adjustments**: The QCD limit will be adjusted for inflation starting in 2024[4].
• One-time election for split-interest entities**: Beginning in 2023, individuals can make a one-time QCD of up to $50,000 (adjusted for inflation) to a charitable remainder unitrust, charitable remainder annuity trust, or charitable gift annuity[4].

QCDs offer several tax benefits:

• Satisfies RMDs**: QCDs can count toward satisfying your RMDs for the year[4].
• Reduces taxable income**: QCDs are excluded from your taxable income, which can help keep you in a lower tax bracket[4].
• Benefits non-itemizers**: Even if you don't itemize deductions on your tax return, QCDs can still provide a tax benefit by reducing your taxable income[4].

Planning for Emergency Expenses

The SECURE 2.0 Act has introduced new provisions to help retirement savers plan for emergency expenses:

1. **Penalty-free withdrawals for emergencies**: Starting in 2024, retirement plan participants can withdraw up to $1,000 per year for emergency expenses without incurring the 10% early withdrawal penalty. The withdrawal must be repaid within three years to avoid taxes and penalties[5].

2. **Workplace emergency savings accounts**: Employers can now offer emergency savings accounts as part of their retirement plans. These accounts allow employees to save up to $2,500 (or lower as set by the employer) in a separate account, with contributions made on an after-tax basis[5].

These new options can provide flexibility and peace of mind when unexpected expenses arise, without jeopardizing your long-term retirement savings.

The Importance of Tax Diversification

As you plan your retirement distributions, it's crucial to consider tax diversification. Having a mix of taxable, tax-deferred, and tax-free (Roth) accounts can give you more control over your tax liability in retirement. With current tax rates set to expire after 2025, now may be an opportune time to consider Roth conversions to shift some of your tax-deferred assets into tax-free accounts[6].

Roth conversions involve transferring funds from a traditional IRA or 401(k) to a Roth account, paying taxes on the converted amount in the year of the conversion. While this may result in a higher tax bill in the short term, it can provide tax-free growth and distributions in the future, potentially saving you money in the long run.

Working with a Financial Advisor

Navigating the complexities of retirement plan distributions can be overwhelming, especially with the recent changes introduced by the SECURE 2.0 Act. Working with a knowledgeable financial advisor can help you make informed decisions and develop a distribution strategy tailored to your unique needs and goals.

A financial advisor can help you:

- Understand the new rules and how they apply to your situation

- Evaluate your distribution options and their tax implications

- Determine the appropriate mix of taxable, tax-deferred, and tax-free accounts

- Assess whether an annuity or other distribution options are suitable for your needs

- Develop a comprehensive retirement income plan that takes into account your expenses, income sources, and long-term goals

By partnering with a trusted financial professional, you can feel more confident in your retirement distribution choices and better prepared for the next chapter of your life.

Conclusion

The SECURE 2.0 Act has brought about significant changes to retirement plan distributions, offering new opportunities and considerations for retirees. By understanding the various distribution options available, the importance of tax diversification, and the potential benefits of working with a financial advisor, you can make well-informed decisions that align with your retirement goals and help ensure a comfortable and secure future.

Remember, everyone's retirement situation is unique, and there is no one-size-fits-all approach to retirement plan distributions. Take the time to educate yourself, explore your options, and seek guidance from a trusted financial professional to develop a distribution strategy that works best for you.

Citations: 

[1] https://www.morningstar.com/retirement/whats-changing-retirement-2024

[2] https://www.cnbc.com/2023/12/31/secure-2point0-changes-coming-for-retirement-savers-in-2024.html

[3] https://www.bankrate.com/retirement/best-retirement-plans/

[4] https://rsmus.com/insights/services/business-tax/new-retirement-plan-distribution-options-introduced-by-secure-2-0.html

[5] https://www.milliman.com/en/insight/client-action-bulletin-secure-2-mandatory-cash-out-limit

[6] https://www.theamericancollege.edu/knowledge-hub/insights/2024-2025-a-critical-window-for-retirement-and-estate-planning

Disclosure: Material prepared herein has been created for informational purposes only and should not be considered investment advice or a recommendation.  Information was obtained from sources believed to be reliable but was not verified for accuracy.  It is important to note that federal tax laws under the Internal Revenue Code (IRC) of the United States are subject to change, therefore it is the responsibility of taxpayers to verify their taxation obligations. 

Savvy Wealth Inc. is a technology company.  Savvy Advisors, Inc. is an SEC registered investment advisor. For purposes of this article, Savvy Wealth and Savvy Advisors together are referred to as “Savvy”.  All advisory services are offered through Savvy Advisors, while technology is offered through Savvy Wealth.  The views and opinions expressed herein are those of the speakers and authors and do not necessarily reflect the views or positions of Savvy Advisors.