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RMDs Driven by Income Level, JCT Study Finds

Practice Management

The size of a required minimum distribution (RMD) one takes may be related to that individual’s income level, the Joint Committee on Taxation (JCT) found in a recent study.

In “Estimating the Effects of the Required Minimum Distribution Rules on Withdrawals from Individual Retirement Arrangements," the JCT reports on research its staff conducted to study the effects of RMD rules on the asset decumulation behavior of retirees with traditional IRAs. The JCT, whose responsibilities include providing Congress with estimates of the budgetary effects of proposed tax legislation and an economic analysis of proposals, says it undertook the study because “understanding the extent to which the required minimum distribution requirements impose a binding constraint on taxpayers and how taxpayers respond to changes in those requirements is important for modeling the revenue effects of policies related to retirement income.”

“Distributions from qualified retirement plans and IRAs generally are included in a taxpayer’s adjusted gross income,” the report notes. While their size “is often at the taxpayer’s discretion,” the JCT says, “in the case of defined contribution plans and IRAs, account-holders must take a required minimum distribution starting at age 70½.” And this will take on added importance, the JCT indicates, since defined benefit plans are declining and not only are defined contribution plans rising, but their balances also “are often rolled over into IRAs as individuals switch jobs or retire.”

The rules governing RMDs require distributions that might have otherwise been delayed, the report notes, which hastens the collection of tax revenue since amounts distributed under the rules generate income tax liability on investment earnings, and RMDs limit the amount of time taxes can be deferred on deductible contributions. “As a consequence, required minimum distributions reduce the tax expenditure associated with the tax deferral on traditional IRA contributions and earnings that accrue to all contributions,” says the JCT.

JCT researchers found “strong and consistent evidence” of IRA withdrawal responses to RMD changes. For instance, in 2008, 2009 and 2010, approximately 20% of 60-year-old IRA holders took distributions, and the percentage increased linearly until age 70, by which approximately 35% took a distribution. They found “a sharp increase” at age 70½, when RMDs become mandatory. The JCT estimates that around 52% of individuals required to make a distribution would rather take a smaller distribution than an RMD.

There also is evidence that the RMD rules induce individuals to close their accounts, the researchers found. The JCT says that their findings indicate that individuals who are first subject to the rules at age 70½ are 28% more likely to do so than those who are over the age of 60 but have not yet attained age 70½.

The JCT found that individuals taking withdrawals near the RMD age 70½ deadline had higher adjusted gross incomes, on average, than those taking withdrawals above the RMD. It attributes this to individuals with more resources at their disposal being more readily able to tap into taxable accounts and more inclined to let their tax-deferred accounts grow. In addition, the JCT says, those taking RMDs and not larger distributions “have substantially larger account balances.”

The JCT did say that there are some “important caveats” concerning the findings. For instance, for a portion of the analysis the JCT used data from 2008 and 2009, a period during which there were “significant fluctuations in asset prices associated with the financial crisis and Great Recession” and that “an analogous suspension during a less volatile time period may have produced different responses.”

Furthermore, the JCT estimates an elasticity that captures the response of withdrawals to a one-year, unexpected change in the RMD. And it notes that the RMD rules were suspended in 2009 in response to the Great Recession. “Individuals who withdrew nothing in 2009 knew that they would be required to make withdrawals the following year, in 2010. If the suspension had been longer than one year, these same individuals may have chosen to take withdrawals in 2009, which would have led to a smaller estimated elasticity relative to that obtained using the one-year suspension.” However, they also said that “a nontrivial fraction of taxpayers” made withdrawals similar to the RMDs that would have been required if the rules had been in place in 2009.