INSIGHT: Repeal of Retiree Required Minimum Distributions May Increase Government Revenue

As part of a spending bill, Congress passed, and President Trump signed on Dec. 20, the “Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019,” which raises to 72 years the age at which retirees generally must take required minimum distributions (RMD) from the traditional (non-Roth) 401(k)/IRA.

Why does Congress impose RMD on any retiree? The motive may be a belief that the distributions will (1) eventually result in more net government revenue, and/or (2) immediately generate genuine revenue. The first rationale may be erroneous, and the second is wrong.

In the long run, a complete repeal of retiree (and spouse) RMD might increase government revenue. The reason is that a traditional 401(k)/IRA is a joint venture with the government and may be a positive-sum game.

Typically, a retiree has a stable taxable income. Several federal tax brackets cover a wide income range. For simplicity, for a retiree and her beneficiary, assume a 30% stable marginal state and federal tax bracket (the tax rate that applies to the next dollar of income). Then, the traditional 401(k)/IRA is a joint venture in which the retiree owns 70%, and the government owns 30%. Of every dollar withdrawn, she or her beneficiary gets 70 cents, and the government receives 30 cents.

Distributions from the traditional 401(k)/IRA are not subject to “tax” in the conventional sense. Instead, they are a partial liquidation of the joint venture with each party taking the share already owned.

Because the retiree’s 70% interest is never subject to tax, including on withdrawals, the 70% interest is like a “Roth” within the traditional. With a stable marginal tax bracket, the tax exemption of this “Roth” is the only tax benefit of the traditional 401(k)/IRA and may represent a revenue loss to the government.

From RMD, the government’s revenue gain, if any, is not the so-called “tax” on the distribution, but any additional tax from the retiree who loses the tax exemption of her “Roth” within the traditional 401(k)/IRA and chooses to reinvest her after-“tax” distribution in securities (or engage in trades in those securities) that generate taxable income.

The government gains no tax revenue as a result of the distribution if the retiree uses the after-“tax” amount in various ways, including (1) spending it, rather than reinvesting it; (2) reinvesting in her state’s tax-exempt municipal bonds; (3) reinvesting in a 529 plan; and (4) reinvesting in non-dividend paying stock and holding until death’s stepped-up basis.

RMD drawdowns may be imprudent for the government. Both owners gain from the traditional 401(k)/IRA’s appreciation in value. When the government withdraws part of its interest in the joint venture and spends the so-called “revenue.” the government “dissaves” and loses any future gains on the amount “dissaved.”

By imposing RMD, the government somewhat resembles the taxpayer who liquidates and spends part of her traditional 401(k)/IRA. Commentators and the government consider imprudent pre-retirement employee withdrawals.

If the government insists on “dissaving” for expenditures, instead of using RMD the government could borrow to spend. Such debt would allow the government to retain its interest in the 401(k)/IRA jointly owned with the retiree. If, as is likely, the 401(k)/IRA generates a higher long-term return than the government’s cost of borrowing, the government will benefit, just as a homeowner profits if her home appreciates at a faster pace than her mortgage rate.

With no compulsory distributions, the appreciation in the government’s interest in the traditional 401(k)/IRA may exceed any tax receipts lost from a retiree who would have elected to reinvest her after-“tax” distributions in a manner that produced taxable income.

Regardless of RMD’s effect on government revenue, the earlier mentioned SECURE Act may make RMD unnecessary. The statute imposes a 10-year mandatory distribution for most non-spousal beneficiaries. As a result, even were there no RMD, affluent retirees and spouses would likely voluntarily take distributions either to finance the Roth conversion or simply to reduce the 401(k)/IRA balance and decrease large annual distributions that thrust the non-spousal beneficiary/heir into a high marginal tax bracket. (The retiree might invest the net proceeds of a voluntary distribution in tax-exempt municipal bonds, a 529 plan, or non-dividend paying stock held until death’s stepped-up basis.) Without RMD, less wealthy retirees and spouses, to finance expenses, might make voluntary withdrawals at least as great as RMD.

In sum, with the SECURE Act, government elimination of RMD for retirees and spouses will have little consequence if retirees and spouses voluntarily make the same or larger withdrawals. Were repeal of RMD to have a slight impact, the result might be to increase net government revenue.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Professor William K.S. Wang is a Sullivan Professor Emeritus at University of California Hastings College of Law. He has taught courses in Corporations and Corporate Finance. From January 2005 through January 2009, Professor Wang served as a member of the FINRA (formerly NASD) National Adjudicatory Council. In addition, from 1996 to 2011 he chaired the Investment Policy Oversight Group of the Law School Admission Council and served ex officio on the LSAC board. Since 2012, he has been on the board of directors of AccessLex Institute and on its investment committee.