Saving money for retirement in a tax-deferred account has many benefits – but you can only defer taxes so long before they must be paid, which is why U.S. tax law requires a Required Minimum Distribution (RMD). An RMD is the amount of money that must be withdrawn annually from a tax-deferred account (including traditional IRAs, SEP IRAs, and Simple IRAs) once the owner reaches a certain age. RMDs are taxed as ordinary income.
Recent legislation including the Setting Every Community Up for Retirement Enhancement (SECURE) Act and the Coronavirus Aid, Relief and Economic Security Act (CARES) Act have created significant changes to RMDs – some of which are ongoing, and some of which are unique to 2020.
The SECURE Act raised the age at which the account owner must begin taking RMDs from the year in which they turn 70½ to the year in which they turn 72.
For those who turned 70½ in 2019, the pre-SECURE Act rule applies, and you would have been required to take your first RMD by April 1st, 2020 – except the CARES Act changed that (see below). For those turning 70½ in 2020 or later, you will be required to take your first RMD by April 1st of the year following the year in which you turn 72.
Although allowing individuals to delay RMDs may be a helpful planning tool for some, many people begin withdrawing funds from these accounts before RMDs are required, so it’s not clear how many people will benefit from this change.
RMDs Waived in 2020
Each year RMDs are calculated based on two things: (1) a life expectancy factor, and (2) the ending value of your account from the prior year – which means 2020 RMD calculations were based partly on December 31st, 2019 ending values.
After the swift pullback we saw in March, many investment account values were substantially lower than where they were on December 31st, 2019. In an attempt to provide some relief to account owners, Congress waived RMDs in 2020:
To ensure that people weren’t forced to take distributions based on a 2019 account value that appeared overstated after the first quarter of 2020;
To allow markets – and by extension investment accounts – time to recover so that people weren’t drawing down on rapidly decreasing accounts.
Anyone already taking RMDs prior to 2020 can skip their RMD for this year only, as well as those who turned 70½ in 2019 (and were subject to pre-SECURE Act rules) but had delayed their first RMD until April 2020.
Because the CARES Act was passed at the end of March, and many people choose to take their RMDs early in the year, it created questions for those who had already taken their 2020 RMD but wanted to roll it back into their account. After several rounds of guidance, the IRS announced on June 23rd that all account owners who already took RMDs in 2020 would be able to roll distributions back into their account until August 31st, 2020.
If you did take an RMD in 2020 and are planning to roll it back into your account, it’s important to note that to fully eliminate the distribution you must deposit the gross distribution amount (both the net distribution you received as well as any taxes withheld).
Planning Opportunities for RMDs
Although you aren’t required to take your RMD in 2020, there are several good planning opportunities for IRA owners – especially in today’s favorable tax environment.
The general rule is that funds withdrawn from a retirement account to satisfy the RMD requirement cannot be converted to a Roth IRA. This means the RMD age account owner wishing to do a Roth conversion must take both their RMD amount and the amount they wish to convert to a Roth into their taxable income. Depending on the size of their RMD and how much they are looking to convert, this could create a substantial tax liability.
With RMD requirements waived in 2020, it may be a good time to consider a Roth conversion strategy with less of a tax burden than in years when RMDs are required.
We’ve written more extensively about Roth conversion strategies in Examining Roth Conversions in the Current Legislative Landscape.
Qualified Charitable Distributions
RMDs can be used to fulfill philanthropic goals through a Qualified Charitable Distribution (QCD). The QCD provision allows individuals over 70½ to donate up to $100,000 from their IRA each year directly to a qualified public charity without having to bring that distribution into their taxable income.
While RMDs aren’t required in 2020, you can still make a QCD. They are an excellent planning tool for IRA owners who are philanthropically inclined. For more information on QCDs, please see our recent Insights article Tax Planning Opportunities for Charitably Inclined IRA Owners.
Between the SECURE Act, CARES Act, and additional legislation many expect before the end of the year, we’ve seen significant changes to the rules surrounding RMDs. We recommend that you consult with your financial advisor and tax advisor to determine what these changes mean for you, and what planning strategies make the most sense given your personal situation.
The information in this article should not be considered investment advice to you, nor an offer to buy or sell any securities or financial instruments. The services, or investment strategies mentioned above may not be available to, or suitable, for you. Consult a financial advisor or tax professional before implementing any investment, tax or other strategy mentioned herein. The information herein is believed accurate as of the time it is presented, and it may become inaccurate or outdated with the passage of time. Past performance does not guarantee future performance. All investments may lose money.