We previously reported that the Coronavirus Aid, Relief and Economic Security (CARES) Act, signed into law last week, makes many important tax law changes for IRA owners and retirement plan participants. Here, we concentrate on one aspect of this new law: the elimination of Required Minimum Distributions (RMDs) from IRAs and retirement plan accounts in 2020. For simplicity sake, here we just refer to IRAs, but the same considerations apply to retirement plan accounts such as 401(k)s. The waiver of RMDs for 2020 raises important questions and provides interesting planning opportunities, some of which are very time sensitive.
The main purpose of the change is to provide greater tax flexibility and to allow IRAs a chance to recover from the recent market decline. The waiver applies to anyone subject to an RMD, including anyone who turned age 70½ in 2019 who did not take an RMD prior to the effective date of the Act. It also applies to beneficiaries of inherited IRAs subject to RMDs. The IRS says that only about 20% of the people subject to RMDs take the minimum amount in any year. Presumably, most of the rest need the additional withdrawals to cover living expenses. For these individuals, the relief given by the CARES Act may not provide much benefit.
For those who have other means to cover living expenses, delaying the RMD can provide both the opportunity for the account balance to recover without a distribution and a meaningful tax break for 2020. These tax savings can be very potent in a year when asset values and income may have declined. Delaying the RMD may also help those who are subject to the IRMAA income-related surcharges on Medicare premiums. There are some circumstances, outlined below, where deferring all distributions from an IRA in 2020 may not be the optimum strategy.
- If deferring the distribution results in the individual having little or no taxable income, it may be advisable to still take a distribution to take advantage of the historically low tax rates. For these individuals, a Roth conversion strategy may provide a great opportunity to convert tax-deferred assets to tax-free assets at very low rates.
- If the market recovers, deferring RMDs in 2020 will result in higher IRA balances in future years, resulting in larger RMDs in those years. Since tax rates are scheduled to increase in 2026, these future RMDs could be taxed at significantly higher tax rates than the current rate. Paying the tax now, at lower rates, may make sense.
- Qualified Charitable Distributions (QCDs) from IRAs still make sense even in the absence of an RMD requirement. QCDs provide the equivalent of a fully tax-deductible charitable contribution, even for those who do not itemize and may provide state and other tax savings.
- The recent changes of the SECURE Act on distribution requirements for non-spouse beneficiaries should also be considered. From a total family perspective, it may still make sense for the parent to take distributions during his or her lifetime to reduce the tax impact on the next generation, especially if the IRA is likely to be inherited in the child’s highest earning years.
For those who have already taken all or a part of their RMD in 2020 prior to the CARES Act passage, the law does not provide relief that would allow prior distributions to be repaid. Perhaps the IRS will issue guidance. Even without this relief, there may be two solutions for those who want to consider undoing prior distributions.
- First, distributions made within the last 60 days could be rolled back into the IRA without taxes. Normally, RMDs are not eligible to be rolled over. However, these prior distributions are no longer considered RMDs and so can be rolled back into the IRA within 60-days of the distribution. This 60-day period is a hard and fast rule which cannot be missed by even one day without significant adverse consequences. Also, these 60-day rollovers can only be done once every 12 months, so keep in mind they either might not be available or may not be advisable depending on the amount and future needs.
- Second, a different provision of the CARES Act provides some tax relief for withdrawals if needed for coronavirus-related events. This provision allows these distributions to be paid back over 3 years and for the tax liability to be spread out over 3 years. Individuals who have unfortunately had such an event before a distribution may be able to take advantage of this change, but it is uncertain whether the change applies to IRA withdrawals before the effective date of the Act. We’ll need guidance on this one.
As is usually the case, these changes raise more questions than they answer. Some questions will have to be answered by the IRS in future guidance. Some of the ideas raised here (like the 60-day rollover or cancelling automatic withdrawals already set up) require immediate attention, while we have more time for others (like whether to a take a distribution in 2020). The best way to answer these questions is to put pencil to paper (or more likely, fingers to keyboards) and run the numbers. Your team at Ancora is standing by to work with you and your tax advisor to help chart the best course. We will also provide updates as we learn more.