Usually, at this time of year, many retired people would have a decision to make concerning their Required Minimum Distribution (RMD) from their IRAs before year-end. However, 2020 has been a very unique year and Congress has actually waived RMDs for this year. Our newsletter this month will discuss potential withdrawal options for 2020, depending upon your personal financial goals and tax planning.
A brief reminder on what an RMD is: A Required Minimum Distributions (RMD) is a required annual distribution of funds from an IRA starting the year in which the IRA owner turns 72. (Please note that any distribution, including RMDs, made to you from most IRAs is taxable as ordinary income. Previously, IRA owners were required to begin their RMDs at age 70 ½, but due to the SECURE Act of 2019 that age requirement has changed to age 72. If you would like to read further on RMDs, please consult our previous newsletter on RMDs, here.
Normally, an IRA owner that has an RMD, has two options: Take the distribution which is taxable or make a Qualified Charitable Distribution (QCD) which reduces the taxable amount of the RMD. But, in March of 2020, due to COVID-19, Congress passed the CARES Act, which contained legislation that waived RMD requirements for 2020. So, this poses the question, what can an IRA account owner do with the funds that would otherwise have been their 2020 RMD?
1. Leave the funds in the IRA-The easiest option this year would be to keep the funds in the IRA. This would allow for continued growth of those funds and postpone paying taxes on any distributions.
2. IRA to Roth-IRA Conversion- IRA owners have the ability to convert a portion of their IRA to a Roth-IRA. Similar to an IRA distribution, these funds will also be taxed as ordinary income as they are converted. The major difference is that rather than the IRA owner receiving the funds, the funds are transferred to a Roth-IRA where the funds can be reinvested and grow tax-free. For an RMD recipient that does not need their RMD money for at least five years or wants to take advantage of a low tax bracket this year, this option could provide them the ability to have their funds invested tax-free until the funds are needed. If, however, the funds are withdrawn before the five-year mark, the earnings will be taxed. The benefit of a Roth-IRA is that they do not have RMD requirements and distributions are tax-free, assuming the rule mentioned above are followed. To get the greatest benefit with this strategy, then the total amount of the conversion should be transferred to the IRA and the required taxes on the converted funds should be paid with money from outside the IRAs. During any other year, an RMD could not be converted to a Roth-IRA contribution, instead you would have had to withdraw the funds to be converted to the Roth-IRA in addition to your RMD withdrawal.
3. Take a Distribution-If you do depend upon your RMDs for living expenses, then this temporary law does not affect you and you should continue to withdraw what is needed. Additionally, if 2020 is a year that your tax rate is low or you feel your tax rate may be higher in future years, you may want to consider making a distribution to take advantage of your lower tax-rate.
2020 has provided some opportunity for those who normally have RMDs. Therefore, IRA owners should know the temporary laws created by the CARES Act and decide if these laws may financially benefit their individual circumstances in 2020. If you have any questions about RMD options, please contact us. As always, because of the tax aspect of RMDs, make sure you consult your tax advisor to review your distribution plan.