The CARES Act essentially suspended required minimum distributions (RMDs) for 2020 across the board. However, there have been a lot of questions about what this means for those who already took out distributions, and the impact on taxes and inherited accounts.
It is important to remember that the CARES Act is a relief bill, and by suspending 2020 RMDs, the government is giving up short-term tax revenue to provide relief to retirees. Additionally, markets have been very volatile, and suspending RMDs gives many Americans the ability to leave their investment portfolios alone to recover over the next year.
In addition to the relief these RMD provisions provide, it also opens up some planning opportunities.
Why does skipping RMDs in 2020 matter? For most people, their IRAs and 401(k)s are funded with tax-deferred dollars. Once the SECURE Act passed in 2019, account owners had to start taking out mandatory, taxable distributions from their retirement accounts at age 72.
With many Americans struggling in 2020 because of the pandemic, having more flexibility on distributions can be beneficial. And since the markets have been extremely volatile, giving retirement portfolios another year to recover can be helpful.
It is important to note that about 20.5% of those subject to RMDs are expected to take only the minimum – most people need these distributions to live off of in retirement. However, the bill now provides them the option to choose for 2020 if they want to take out money or not.
There is some confusion as to if this flexibility pertains to inherited IRAs and 401(k)s. The bill suggests that it pertains to any RMD from any individual-account retirement plan, which should include inherited IRAs or 401(k)s. This position is bolstered by the purpose of the bill itself: to provide relief to Americans during this pandemic emergency.
This is not a technical tax bill looking for revenue, so expect the IRS and the government to interpret the bill under that notion.
The bill also deals directly with specific types of inherited accounts, such as those going to an estate, charity, or certain type of trust at death. These types of beneficiaries – non-designated beneficiaries who inherit a retirement account from a decedent who died before their required beginning date – typically have to distribute the account within five years of the death of the owner. The CARES Act states that if one of the five years is 2020, beneficiaries get an extra year, turning a five-year rule into a six-year rule. This group usually gets less favorable RMD rules than other beneficiaries, so we can expect that inherited RMDs across the board are pushed off for 2020.
If someone already took an RMD for 2020, which some people do in the first week of January, they’re likely out of luck. There is no provision in the bill that allows someone to put back a distribution taken in 2020. The distribution will still be treated as such and therefore taxable.
For those who won’t need their RMDs and have them set up automatically, now is a good time to consider suspending your RMDs for 2020.
However, one strategy that can be used is if someone took an RMD from an IRA or 401(k) within the last 60 days, they can do a 60-day rollover to an IRA and not have it treated as a taxable distribution in 2020.
Let’s say you had an RMD of $15,000 for 2020 and you took it out on March 1, 2020. You have 60 days from March 1, 2020, to roll over $15,000 into an IRA. If you do, it will count as a 60-day rollover and the amount won’t be taxable. If the 60 days pass, you might not be able to get the money back into an IRA. You only have one 60-day rollover per 12-month period.
Could the Coronavirus-related distribution exception play an RMD role? The CARES Act also created a new exception to the 10% early withdrawal penalty tax under code section 72(t) for those who take retirement distributions prior to age 59.5.
In 2020, Americans impacted by the coronavirus crisis can take out up to $100,000 from their IRA or 401(k) without penalty tax. The distribution would be subject to normal taxation rules regarding distributions.
By default, the taxable distribution is spread out over three years, but can be treated as taxable income in 2020 if desired. This might make sense if 2020 is a low-income year.
To be eligible for the exception, the account owner or their spouse needs to be diagnosed with COVID-19, or they need to experience adverse financial consequences as a result of the pandemic due to being quarantined, laid off, furloughed, have reduced housing, childcare issues, or a number of other reasons. This exception is incredibly broad as most Americans will be impacted in some way.
This new provision is not tied directly to RMD rules, but it does allow the individual to repay the amount as a qualified rollover contribution, beginning on the day after receipt of a coronavirus-related distribution.
While this was not designed to help people repay distributions, if someone took what they thought was an RMD early in January of 2020, they could potentially treat that distribution as a coronoavirus-related distribution and repay it over the next three years, or even in 2020.
Again, while this was not the design of this provision, it is very likely that this provision will be interpreted broadly. If you meet the requirements, it seems like most distributions in 2020 up to $100,000 can be repaid over the next three years if the owner was impacted by COVID-19. Since, there are no RMDs owed in 2020, this would now be eligible to be rolled over, too, whereas without the RMD waiver that amount would not be eligible for a rollover.
Someone could take out a Coronavirus-related distribution in 2020 of up to $100,000 and repay it in the next three years. They can file amended returns at that time to claim refunds for the taxes paid on the distribution, because once repaid, it’ll be an eligible rollover and not taxable. Without the RMD waiver, it would not be eligible for a rollover.
It is possible the IRS tries to limit this aspect to only those under age 59.5, even though nothing in the bill suggests that is required. But, since the penalty tax typically only applies to those under age 59.5, one could argue that the exception also only applies to that group.
It seems that the payback aspect of this is to give people relief to funds and an ability to pay back. I expect this provision to be interpreted broadly and include rollovers of most distributions from retirement accounts in 2020 over the next three years if the owner decides they want to repay the account.
Source: Forbes.com
Sincerely,
Fortem Financial
www.fortemfin.com
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