There is a tax deadline coming up. It may matter to
those who are taking required minimum distributions (MRDs) from your IRAs and certain
employer-based plans.
You may recall that there is a trigger concerning
retirement plans when one reaches age 72.
COMMENT: The trigger used to be age 70 ½ for tax years before 2020.
The trigger is – with some exception for
employer-based plans – that one has to start withdrawing from his/her retirement
account. There are even IRS-provided tables, into which one can insert one’s age
and obtain a factor to calculate a required minimum distribution.
COMMENT: There are severe penalties for not withdrawing a minimum distribution. Fortunately, the IRS is fairly lenient in allowing one to “catch-up” and avoid those penalties. At 50% of the required distribution, the MRD penalty rate is one of the most severe in the tax Code.
Let’s say that you are in the age range for MRDs. You have,
in fact, been taking monthly MRDs this far into 2020.
There has been a law change: you can take 2020 distributions
if you wish, but distributions are not mandatory or otherwise required. That
is, there are no MRDs for 2020. This means that you can take less than the
otherwise-table-calculated amount (including none, if you wish) and not taunt
that 50% penalty.
Why the change in tax law?
The change is related to the severe economic
contractions emanating from COVID and its associated lockdowns and stay-at-home
restrictions. Congress realized that there was little financial sense in
forcing one to sell stocks and securities into a bear market to raise the cash
necessary to pay oneself MRDs.
Hot on the heels of the change is the fact that
different people take MRDs at different times. Some people take the
distribution early in the year, others late, and yet others take distributions monthly
or quarterly. There is no wrong answer; it just depends on one’s cash flow needs.
Let’s take the example we started with: monthly distributions.
Well, it’s fine and dandy that I do not have to take
any more distributions, but what about the amount I took in January -before the
law change? And February – before …., well, you get the point.
You can put the money back into the IRA or retirement
account.
Think of it as a mulligan.
But you have to do this by a certain date: August 31,
2020.
You have approximately another month to get it done.
Here are some questions you may have:
(1) Does this change apply to 401(k)s, 403(b)s,
457(b)s?
Answer:
Yes.
(2) How about inherited accounts?
Answer: Yes. You have to
put it back in the same (that is, the inherited) account, of course.
(3) What if I was having taxes withheld?
Answer: You are going to
have reach into your pocketbook temporarily. Say that you took a $25,000 distribution
with 20% federal withholding. You never spent any of it, so you have $20,000
sitting in your bank account. If you want to unwind the entire transaction, you
are going to have to take $5,000 from somewhere, add it to the $20,000 you
already have and put $25,000 back into your IRA or retirement account.
You may wonder what
happened to the $5 grand that was withheld. It will be refunded to you – when you
file your 2020 tax return.
(4) Continuing with Example (3): what if I don’t
have the $5 grand?
Answer: Then put back the
$20,000 you do have. It’s not 100%, but you put back most of it. You will have
that gigantic withholding when you finally file your 2020 taxes.
(5) What if I turned 70 ½ last year (2019) and
HAVE TO take a MRD in 2020?
Answer: The answer may surprise
you. The downside to waiting is that you would (normally) have to take a
distribution for 2019 (you turned 70 ½, after all) and another for 2020 itself.
This means that you are taking two MRDs in one tax year. Under the new 2020 tax
law, you do not have to take EITHER (2019 or 2020) distribution. Your first
distribution would be in 2021, and you would have had no distributions for 2019
or 2020.
(6) Does this change apply to pensions?
Answer: No. Pensions are “defined
benefit” plans, whereas IRAs, 401(k)s and so on are “defined contribution”
plans. The change is only for defined contribution plans.
(7) Does this change apply to Roths?
Answer: Roths do not have
minimum required distributions, so this law change means bupkis to them.
(8) What if I went the other way: I withdrew from
my traditional IRA and would like to put it back as a Roth?
Answer: Normally one
cannot do this, as MRDs do not qualify for a Roth conversion. With no MRDs for
2020, however, you have a one-time opportunity to flip some of your traditional
IRA into a Roth. Remember that you will have to pay tax on this, though.
(9) How does this law change interact with the qualified
charitable distribution rules?
Answer: A qualified charitable
distribution (QCD) is when you have your IRA custodian issue a check directly
to a charity. You do not get a deduction for the contribution, but the upside
is that you do not have to report the distribution as income. If you do not itemize
deductions, this technique is – by far – the most tax-efficient way to go. The QCD
rules are independent of the MRD 2020 rule change. If you want to donate via charitable
distributions in 2020, then go for it!
If you are already into your MRD for 2020 and do not
need the money – some or all of it – remember that you have approximately
another month to put it back.
