You’ve probably heard a lot of chatter recently about Required Minimum Distributions, or RMDs, in the media. Some of our clients have asked us about the increased focus on RMDs this year — or, in the words of Saturday Night Live’s Emily Litella, “What’s all this fuss I keep hearing about RMDs?”
The reason we are hearing more about RMDs in 2020 is because of three key pieces of legislation that were passed during the last six months.
- SECURE Act – The first piece was the Setting Every Community Up for Retirement Enhancement Act — known as the SECURE Act — that was passed in December 2019. Under the SECURE Act, the starting age for RMDs shifted from age 70½ to age 72.
- CARES ACT – When COVID-19 caused the markets to crash in March, Congress passed the Coronavirus Aid, Relief and Economic Security Act (or “CARES Act”), which suspended RMDs for most retirement accounts, including inherited IRAs. While the CARES Act allowed taxpayers to return some of the distributions they had already taken, there were restrictions.
- Further legislative action (IRS Notice 2020-51) – Recent legislation lifted many of the previous restrictions, allowing taxpayers to return all distributions they had already taken in 2020.
With so many changes to the rules in recent months, and given that RMDs do not really “exist” in 2020, we want to explain where things stand today and what considerations to have in mind when deciding to take, or skip, or return any 2020 IRA distributions.
What Is An RMD? Why Do They Exist?
An RMD is the amount of money that must be withdrawn each year from a traditional IRA (including a SEP or SIMPLE plan) or a qualified employer plan by account owners who have reached 72 years of age (prior to 2020, it was 70½). RMDs provide a steady flow of tax revenue for the federal government each year, which is why failure to take an RMD results in a whopping 50% tax penalty on the RMD amount.
Why Did Congress Make Changes This Year?
Since RMDs are calculated based on the prior year’s December 31st account balance, the COVID-19 pandemic created many challenges for retirees. On December 31st, 2019, the S&P 500 closed at roughly 3,230 — almost 1,000 points higher than the market’s low during mid-March 2020. This meant that many taxpayers would have been required to take RMDs on a retirement account value that had significantly declined.
To give taxpayers a break and allow their investments time to recover, the CARES Act suspended most RMDs for 2020, followed later by an IRS rule change that allowed all IRA distributions (whether an RMD or a voluntary withdrawal) to be skipped (or returned) for 2020.
Should You Take Any IRA Distribution in 2020, Or Sit This Year Out?
So, what’s the right path for you, your family, and your wealth? Below are the key considerations when thinking about whether to take, or skip, any IRA distribution in 2020.
Reasons Why You Should Take an IRA Distribution in 2020
- To take advantage of low income in 2020
If the COVID-19 pandemic has negatively impacted your income for 2020, it might make sense to take your RMD this year. RMDs are taxed as ordinary income, so the lower your “base” income is for 2020, the less chance that an RMD will push you into a higher tax bracket.
- To do a Roth Conversion
According to the Chinese Zodiac calendar, 2020 is the Year of the Rat, but for many retirement savers, 2020 will be the “Year of the Roth.” If you’ve been considering a Roth IRA conversion, doing so this year might make sense, especially if your retirement account value has decreased and/or your income levels are lower than normal.
- To make a Qualified Charitable Distribution (QCD)
With RMDs suspended in 2020 and a high standard deduction, making a QCD in 2020 will not offer a tax break, but it will likely lower the value of the IRA and, thus, the amount of future RMDs. The other reason to make a QCD in 2020 is, of course, to help others in need.
- To use the money for living expenses
Perhaps the most obvious reason to take an IRA distribution is if you simply need the money for living expenses. It’s also important to remember that there is no minimum or maximum limit on IRA withdrawals this year. So if you do need the money, you can withdraw however much you need and pay taxes on the distribution as usual.
Why You Should Skip Taking an IRA Distribution in 2020
- To protect your retirement account balance
Let’s say your 2020 RMD would have been $50,000, and your effective tax rate is 40%. On the RMD, you would pay $20,000 in taxes and net $30,000. If you didn’t take the distribution, you leave $50,000 in your retirement account to grow, and you save $20,000 in taxes this year. Leaving those funds invested inside the tax-protected IRA will help build more wealth over time.
- To reduce your taxable income
If you don’t need the money this year or you have other sources of income to make up the difference, skipping, what would have been your RMD will likely reduce your taxable income. For those that are especially focused on tax minimization and don’t need the money this year, skipping the distribution is likely the best path.
What If You Already Took Your 2020 RMD?
If you’ve already taken your RMD (or any voluntary IRA distribution) for 2020, there’s still time to recontribute the funds.
Originally, the rules allowed for only certain RMDs taken during a defined timeframe to be redeposited. On June 23rd, however, the IRS enacted a revision to that rule (IRS Notice 2020-51), allowing all investors who took any IRA distribution in 2020 to roll those amounts back into the IRA. The new deadline for rolling back this year’s distributions is August 31 — regardless of when during 2020 the funds were withdrawn. After the August 31 deadline, the exceptions are likely to end, so if you’re considering rolling back your RMD for this year, you’ll want to act soon.
How to Decide
Ultimately, whether to take or skip what would have been your 2020 RMD or any IRA distribution comes down to your specific financial needs, goals, and tax situation. If you have any questions about the information covered or how it might affect your planning, we can help. Reach out to your advisor at Strategic Wealth Partners to discuss your options.