No Required Minimum Distributions For 2020

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.

Year-End Retirement Tax Changes

On Friday December 20, 2019 the President signed two spending bills, averting a government shutdown at midnight.

The reason we are talking about it is that there were several tax provisions included in the bills. Many if not most are as dry as sand, but there are a few that affect retirement accounts and are worth talking about.

Increase the Age for Minimum Required Distributions (MRDs)

We know that we are presently required to begin distributions from our IRAs when we reach age 70 ½. The same requirement applies to a 401(k), unless one continues working and is not an owner. Interestingly, Roths have no MRDs until they are inherited.

In a favorable change, the minimum age for MRDs has been increased to 72.

Repeal the Age Limitation for IRA Contributions

Presently you can contribute to your 401(k) or Roth past the age of 70 ½. You cannot, however, contribute to your IRA past age 70 ½.

In another favorable change, you will now be allowed to contribute to your IRA past age 70 ½.

COMMENT: Remember that you generally need income on which you paid social security taxes (either employee FICA or self-employment tax) in order to contribute to a retirement account, including an IRA. In short, this change applies if you are working past 70 ½.

New Exception to 10% Early Distribution Penalty

Beginning in 2020 you will be allowed to withdraw up to $5,000 from your 401(k) or IRA within one year after the birth or adoption of a child without incurring the early distribution penalty.

BTW, the exception applies to each spouse, so a married couple could withdraw up to $10,000 without penalty.

And the “within one year” language means you can withdraw in 2020 for a child born in 2019.

Remember however that the distribution will still be subject to regular income tax. The exception applies only to the penalty.

Limit the Ability to Stretch an IRA

Stretching begins with someone dying. That someone had a retirement account, and the account was transferred to a younger beneficiary.

Take someone in their 80s who passes away with $2 million in an IRA. They have 4 grandkids, none older than age 24. The IRA is divided into four parts, each going to one of the grandkids. The required distribution on the IRAs used to be based on the life expectancy of someone in their 80s; it is now based on someone in their 20s. That is the concept of “stretching” an IRA.

Die after December 31, 2019 and the maximum stretch (with some exceptions, such as for a surviving spouse) is now 10 years.

Folks, Congress had to “pay” for the other breaks somehow. Here is the somehow.

Annuity Information and Options Expanded

When you get your 401(k) statement presently, it shows your account balance. If the statement is snazzy, you might also get performance information over a period of years.

In the future, your 401(k) statements will provide “lifetime income disclosure requirements.”

Great. What does that mean?

It means that the statement will show how much money you could get if you used all the money in the 401(k) account to buy an annuity.

The IRS is being given some time to figure out what the above means, and then employers will have an extra year before having to provide the infinitely-better 401(k) statements to employees and participants.

By the way …

You will never guess this, but the law change also makes it easier for employers to offer annuities inside their 401(k) plans.

Here is the shocked face:

 Expand the Small Employer Retirement Plan Tax Credit

In case you work for a small employer who does not offer a retirement plan, you might want to mention the enhanced tax credit for establishing a retirement plan.

The old credit was a flat $500. It got almost no attention, as $500 just doesn’t move the needle.

The new credit is $250 per nonhighly-compensated employee, up to $5,000.

At $5 grand, maybe it is now worth looking at.