I understand that almost all retirement vessels have RMDs (Roth IRAs being one of the few exclusions) but I'm uncertain why the IRS requires them? What purpose does it serve the government to force people to take RMDs (particularly if they don't need the money) other than the taxable event that occurs with a distribution (Roth 401k distributions aside)? Does it all essentially boil down to the government wanting to at least acquire some of the tax revenue that would come with RMDs rather than letting retirees continue to squirrel it away and protect it via estate planning and the exemption limit? Does it also relate to the government hoping that RMDs will induce the retiree to spend some of it and hence contribute to the overall economy? I hate the idea that the government has essentially forced retirees (with me being one in ~35 some odd years) into taxable events regardless of their actual need for THEIR retirement funds.
You have captured the major reasons. RMDs are calculated by applying life expectancy factors to the prior end of year balance in the account. The idea is to come close to liquidating the account over a normal life expectancy. People were given the right to defer taxes as an incentive to build an account which they would then rely on retirement to help add to social security benefits, thereby becoming less dependent on those benefits.
Colin, You did an excellent job of answering your own question. The fact that the government does not want people deferring taxes indefinitely is one of the reasons why I'm a big fan of Roth IRA's and Roth 401Ks. The Roth is commonly overlooked by many individuals, CPAs and financial advisors because so many don't understand the real benefit of forgoing a tax deduction today in exchange for being able to withdraw a larger sum of money completely tax free in the future. Investors and their financial advisors are so focused on wanting a tax deduction today that they fail to realize that it's often better to pay a tax on the seed you plant (i.e. forgoing the tax deduction) than the much larger harvest you will reap in the future. So, if you qualify to contribute, take advantage of the Roth IRA and Roth 401K and use the tax codes to your advantage.
Hello Colin, you are correct in your reasoning for the RMD. If the government did not have restrictions on the contributions and the withdrawals some people might put all of their earnings in an IRA and never take it out, thus leaving the government without an income. Heavens! However, you can still save money into a regular non-qualified account and not have the rules and regulations of the various retirement plans to contend with. That way you can thumb your nose at Uncle Sam and do what you want. Your government wants to encourage people to save for retirement that's what all the tax deferred or tax free IRA's/401(k)'s etc. rules are about. The main thing is to plan for your retirement starting with how you want to retire in financial independence. How you save for retirement is then a choice of what savings accounts you want to use. You can save by your own rules or use the rules laid down by Uncle Sam. Good luck and get a plan in place!
You touched on all the major reasons the government forces most retirement accounts to be distributed each year. I would also add that they would like to see people tap into their retirement accounts slowly over their retirement years like the RMD requires as opposed to taking out large lump sums that raise the risk of the person outliving their accounts and needing financial assistance from the government to help fund their last years. I always try to create a financial plan with my clients that only requires them to take out the minimum required so that we have more confidence in not outliving the assets and even leaving some behind to their children. Its a good situation to be in to only have to take out the RMD amount and nothing more each year.
Colin - I would say that all of those reasons apply to the rationale for RMD's. The adage about death and taxes applies!
Colin, your intuition about RMDs is correct and the answers you have received confirm that. It's the reason why many RIAs strongly recommend Roth IRAs and 401(k) plans for people who are as far from retirement as you are. The government spending trajectory is up and where spending goes taxes will certainly follow. The Reagan era represent the low point in tax rates for the lifetime of most people. Rates have been rising since then and unless there's a major shift in Washington's policy, they will be higher when you retire. Go Roth.
Colin, The timing of your question is good as the end of the year approaches. Required Minimum Distributions (RMD) from tax-deferred retirement accounts catch some investors by surprise. The government forces these distributions because the money has never been taxed and never would be taxed if investors used the funds for estate planning. Our government has an appetite for taxing (and spending) that is never satisfied. Investors are well served to dutifully take the RMD (starting at age 70). Failure to take the RMD results in a stiff penalty of 50% of the amount that should have been taken out!
You've hit the nail on the head in answering your own question. You now have a good insight into how our tax code has changed over the generations - from an original purpose of funding the legitimate activities of the Federal government - to using the tax code as an instrument of social change. Other examples: tax credits for clean energy; earned income tax credit; etc. From their point of view, the Feds have "let" you keep your deferred funds and associated gains with no taxation until age 70 1/2. Then the RMD forces you to begin explosing it to taxation.
IRS does not pass tax laws. Congress passes tax laws. If you did not have RMD's Congress would either have to tax someone else or cut spending on something else. As most tax laws pass as a compromise there is sometimes no logic in the end tax bill.