2020 has been a unique year in many ways. In the tax world, there have been constantly changing deadlines, new tax laws, and one-time changes to existing rules. We’ve been busy keeping up with all these changes and thinking about the tax planning opportunities they created for our clients.
One important change that could significantly impact taxes for retirees this year was the waiver of required minimum distributions (RMD’s) for 2020. Before we get into this change, let’s take a step back and look at the RMD rules, which were already set for changes under the SECURE Act starting in 2020.
There has always been a requirement that taxpayers must begin taking distributions from their retirement accounts once they reach a certain age. These RMD’s are based on the account value as of the end of the prior year, divided by a distribution period that is determined by your age. This period declines each year as you get older, so the amount you must withdraw generally increases over time.
Prior to this year, your first RMD had to be taken by April 1st of the year after you turn 70.5. However, the SECURE Act, which was passed in December last year, changed the age requirement to 72. Anyone who had not yet turned 70.5 by the end of 2019 is now able to wait until they turn 72 to start taking distributions. Keep in mind RMD’s actually start the year you turn 72, so while you CAN delay the first distribution to April 1st of the next year, you’d then be required to take TWO RMDs that year.
The vast majority of taxpayers take more than their minimum required amount each year in order to fund their living expenses in retirement. However, many taxpayers have a variety of different account types they can rely on for retirement income, so they might only have to take out this minimum amount required by the IRS.
The Coronavirus Aid, Relief, and Economic Security, or CARES Act, was passed earlier this year. Included in the bill was a waiver of all RMD’s for 2020, including those from 401(k)’s, IRA’s AND inherited IRA’s. If someone had already taken their RMD this year, they were permitted to “undo” that distribution and treat it as a rollover back into an IRA up until August 31st.
If you are able to cover your cash flow for this year from sources other than your retirement accounts, the waiver of their RMD might put you in a much lower tax bracket than normal. With tax rates overall at historically low levels, and government spending at historically high levels, most experts agree we are likely to see higher tax rates in the future.
Tax planning advice has historically been centered on deferring income and therefore deferring the tax bill as long as possible. However, if tax rates might be higher in the future and you are in a low tax bracket now, you should consider accelerating income into this year. So, how do you think about doing this?
Everyone’s tax situation is different, and the best planning strategy for one person might not be the best for another. One example would be someone who has very little income outside their RMD’s. This could put them into the 0% capital gains tax bracket, allowing them to trigger gains in their investment accounts with no federal tax impact. Remember, there is no IRS rule against taking a gain and repurchasing the same security, that only applies to losses.
Another way to take income this year would be to look at doing partial Roth conversions to fill up lower tax brackets. You might think of a Roth IRA as an investment vehicle for younger individuals, but they can be beneficial regardless of your age. When you do a Roth conversion, you pay tax on the conversion amount now, but then you can withdraw that money in the future tax-free. There are no RMDs for Roth IRA’s, so that money can grow tax-free as long as you want, and they make a great type of account to pass down to heirs who will also be able to take distributions out tax-free.
Roth conversions have become even more valuable for anyone with large retirement accounts under the SECURE Act, which now requires inherited IRA’s to be taken out within 10 years. Beneficiaries no longer have the ability to stretch out those distributions over their life expectancy, and this could mean a bigger tax bill for themselves.
Another item to consider is that even though RMD’s were waived for this year, you are still allowed to do a Qualified Charitable Distribution (QCD). If you are charitably inclined, you can do a distribution of up to $100k directly from your retirement account to the charity. In most years this would offset the RMD amount, but it still might make sense this year if you have a large retirement account balance, as it allows you to get money out of the IRA tax-free and achieve your charitable giving goals.
As you can tell, there are many unique planning opportunities to consider before the end of this year. If you have any questions about how these changes might impact you, please feel free to reach out to us.
-Chris Benson, CPA, PFS
The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person.
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