If you are over the age of 72 and have a traditional IRA or qualified employer retirement plan, you must take Required Minimum Distributions (RMDs) each year. Failure to do so can result in a 50% “excess accumulation” tax penalty on the amount that was not distributed; in other words, if your RMD is $50,000, the tax penalty is $25,000.
Normally, taking your annual RMD is fairly straightforward. However, 2020 saw significant changes to RMDs, first with legislation making changes to when RMDs must begin, and then with changes for 2020 in connection with the legislative response to the COVID-19 pandemic. In light of these changes, planning your RMD for 2020 is especially important.
In this article, we will explain what to consider as you decide whether to take your 2020 RMD. If you’ve already taken it, skip to the last section, where we discuss the factors that could influence whether or not you recontribute the funds.
If You Have Not Taken Your 2020 RMD, Should You?
In March, the CARES Act suspended RMDs for 2020, and many people are weighing whether to take their RMD this year. If you are unsure, consider these questions:
Do you need the funds to cover living expenses?
If you rely on your RMD to cover living expenses, you should still take your 2020 RMD.
Will taking your 2020 RMD push you into a higher tax bracket?
RMDs are taxed as ordinary income, and your RMD can move you into a higher tax bracket. Normally, you wouldn’t have a choice; however, this year you can forego your RMD and potentially lower your taxable income. This strategy can be especially effective if you are approaching the threshold between two tax brackets. For example, those who are married and filing jointly will move from the 24% tax bracket to the 32% tax bracket when they reach $171,051 in income. If foregoing your RMD will help keep you in a lower tax bracket in 2020, and you don’t need the money for living expenses, it might be the right decision.
Will taking the RMD affect your tax deductions or federal stimulus eligibility?
Some tax deductions — like the 3.8% Medicare surtax — start to phase out after you reach a certain income threshold. Additionally, higher income could also impact your eligibility for future government stimulus checks, as the stimulus payments in the CARES Act were on an income-based sliding scale. Skipping your 2020 RMD could help ensure your eligibility for both.
Is it important to maintain the size of tax-deferred retirement accounts?
The markets were exceptionally volatile earlier this year. If the positions within your tax-deferred accounts haven’t fully recovered from the earlier downturn, you may want to hold these assets to give them more time to recover. Skipping this year’s RMD can help prevent you from liquidating positions that haven’t yet fully recovered in value.
Are you concerned that marginal tax rates will increase in the future?
There are concerns that marginal tax rates will increase in 2025, when many provisions of the Tax Cuts and Jobs Act of 2017 are set to expire. If you are concerned about the future trajectory of the U.S. tax code, it might make sense to take your RMD in 2020 and pay the taxes today, while most tax rates are at historic lows.
If You Have Taken Your 2020 RMD, Should You Return It?
Many people had already taken their 2020 RMD when the CARES Act passed in March. If you are considering returning this year’s RMD, IRS Notice 2020-51 allows you to do so — provided you make “full restitution” on the RMD amount by August 31st. This means that If you took an $80,000 RMD in February of 2020, you have until August 31st to recontribute the full $80,000.
One caveat is that most RMDs taken include income tax withholding, that is remitted directly to the government. For someone in the 25% tax bracket, $20,000 of their $80,000 RMD would go to the tax withholding account. Unfortunately, this is where things can get complicated.
To make full restitution, you must return the full $80,000 before August 31st — but you likely can’t access the funds in the tax withholding account. In other words, you’d need to contribute $20,000 out of your own pocket now, with the $20,000 in the withholding account to be refunded by the IRS at a later date. Depending on when you file, however, this could take between six months to a year. This is effectively an interest-free loan to the U.S. Treasury and, for that reason, many people who have already taken RMDs in 2020 are electing to keep the money.
Why might it make sense to recontribute the funds? As we detailed in the previous section, if it’s important for you to keep your ordinary income levels low and maintain tax-deferred retirement account balances, recontributing your 2020 RMD could be the best course of action.
We Are Here To Help
There are a lot of moving pieces when it comes to effectively managing RMDs, and the new laws make this year particularly challenging. If you have any questions or want to discuss your options, please don’t hesitate to get in touch. We can help you think through the best strategic path forward for you and your family.
ABOUT THE AUTHOR: JEFFREY FOSSELMAN, CFP®, CPA/PFS, JD
As Senior Wealth Advisor for Relative Value Partners, Jeff provides comprehensive advisory services in estate planning, income tax planning, cash flows, asset allocation and other financial planning areas. With more than a decade of experience in the industry, Jeff is instrumental in delivering financial planning strategies and counsel to high-net-worth individuals.
Jeff is also an attorney and has provided basic legal services in the areas of business consultation, formation of legal entities and drafting of estate planning documents.
After graduating with a Bachelor of Science from the University of Illinois in 2000, Jeff continued his studies and earned his Juris Doctor from the University of Illinois College of Law in 2003, and a Master of Science in Taxation from DePaul University’s Charles H. Kellstadt Graduate School of Business in 2010. He is also a member of the American Institute of CPAs – Personal Financial Planning Section and holds a CPA license with a Personal Financial Specialist designation. Finally, Jeff also holds the Certified Financial Planner (CFP®) designation.
Information contained in this article is obtained from a variety of sources which are believed though not guaranteed to be accurate. Past performance does not indicate future performance. This article does not represent a specific investment recommendation.
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