When you consider your retirement income sources, Social Security and traditional pension plans often come to mind. With more employers making use of defined contributions plans such as 401(k)s, many people have also built up retirement savings balances from which they must take required minimum distributions (RMDs) once they reach age 72 (increased from age 70 ½ by the Setting Every Community Up for Retirement Act, aka SECURE). Sometimes those retirement plan balances are substantial, resulting in large RMDs that might be more than what is needed to cover living expenses when combined with other retirement income sources. We sometimes hear from people that they don’t really want their RMDs because it just increases their tax liability.
Well those folks are in luck – at least for this year. The Coronavirus Aid, Relief, & Economic Security (CARES) Act waives RMDs from defined contribution plans for 2020. This waiver does not apply to defined benefit plans or non-governmental 457(b) plans. It does, however, apply to inherited IRAs (remember, inherited Roth IRAs have RMDs too).
Perhaps to get their RMDs over with, some people took distributions from their retirement accounts very early in 2020. Others may have set up recurring distributions that in aggregate would satisfy their RMDs for the year. Once the CARES Act passed in late March, they were seemingly stuck with RMDs that were no longer actually required – unless the distribution was able to be put back into the account under the 60-day once-every-12-months rollover rule. The 60-day rollover provision wasn’t available at all in the case of distributions from inherited IRAs.
Recent IRS guidance provides relief for such individuals. If you don’t want, or need, what you withdrew as a no longer required RMD, you have until the later of 60 days from the distribution date or August 31, 2020, to return it. This applies to distributions taken on or after January 1, 2020. Returning the distributions also doesn’t count as your one 60-day rollover permitted in a 12-month period. And this relief is extended to inherited IRAs.
If you’re not looking to return funds that you distributed thinking they were RMDs, distributions received between January 1, 2020, and December 31, 2020, that would have been RMDs if not for the CARES Act (including inherited IRA RMDs) are permitted to be treated as coronavirus-related distributions which can be included in income equally over three years. Such distributions are limited to $100,000 and must be made to a qualified individual. For purposes of the coronavirus-related distribution rules, you are a qualified individual if:
- You, your spouse, or your dependent are diagnosed with COVID-19.
- You experience adverse financial consequences as a result of you, your spouse, or a member of your household:
- Being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19;
- Being unable to work due to lack of childcare due to COVID-19;
- Having a reduction in pay (or self-employment income) due to COVID-19;
- Having a job offer rescinded or start date for a job delayed due to COVID-19; or
- Closing or reducing hours of a business that you own or operate due to COVID-19.
If you’re a qualified individual as a result of experiencing adverse financial consequences as described above, coronavirus-related distributions are permitted without regard to the need for funds, and the amount of the distribution is not required to correspond to the extent of the adverse financial consequences that you experienced. If you are eligible to treat the distribution as a coronavirus-related distribution and choose to do so, you could potentially repay it later within three years of receiving it – but that option is not available to beneficiaries, other than surviving spouses, who took a distribution from an inherited retirement plan.
Finally, 2020 may be a great year to consider a Roth conversion. Generally, RMDs are not permitted to be converted to Roth IRAs. However, with RMDs waived for 2020 you could convert the amount of what would have been your RMD (or some other amount depending on your current year tax situation) to a Roth IRA, thus reducing your RMDs in future years and creating a tax-free asset for your heirs (which they’ll most likely have to distribute over 10 years due to SECURE). While not prohibited as the CARES Act is written, several IRA experts have advised against taking a coronavirus-related distribution and shifting the funds to your Roth IRA as a Roth conversion while trying to spread the tax on the conversion over three years. They anticipate that this loophole will be closed, perhaps retroactively causing the full distribution to be taxed in 2020 with no option to recharacterize after year-end since that was eliminated under the Tax Cuts & Jobs Act (TCJA).
Thanks to the CARES Act and this recent additional guidance from the IRS, there are many expanded planning opportunities with respect to the waiver of 2020 RMDs. Contact your advisor or go to https://www.sequoia-financial.com/talk if you would like to discuss your individual circumstance.