CARES Act RMD Relief

CARES Act RMD Relief for 2020

Posted On March 30, 2020 By Scott Stratton, CFP(R), CFA In College Savings, Financial Planning, Tax Strategies /  

The Coronavirus Aid, Relief, and Economic Security CARES Act approved this weekend eliminates Required Minimum Distributions from retirement accounts for 2020. If you have an inherited IRA, also known as a Stretch or Beneficiary IRA, there is also no RMD for this year. We are going dive into ideas from the CARES Act RMD changes and also look at its impact on charitable giving rules.

Of course, you can still take any distribution that you want from your retirement account and pay the usual taxes. Additionally, people who take a premature distribution from their IRA this year will not have to pay a 10% penalty. And they will be able to spread that income over three years.

RMDs for 2020

Many of my clients have already begun taking their RMDs for 2020. (No one would have anticipated the RMD requirement would be waived!) Can you reverse a distribution that already occurred? Not always. However, using the 60-day rollover rule, you can put back any IRA distribution within 60 days.

If you had taxes withheld, we cannot get those back from the IRS until next year. However, you can put back the full amount of your original distribution using your cash and undo the taxable distribution. You can only do one 60-day rollover per year.

For distributions in February and March, we still have time to put those distributions back if you don’t need them. Be sure to also cancel any upcoming automatic distributions if you do not need them for 2020.

If you are in a low tax bracket this year, it may still make sense to take the distribution. Especially if you think you might be in a higher tax bracket in future years. An intriguing option this year is to do a Roth Conversion instead of the RMD. With no RMD, and stocks down in value, it seems like a ideal year to consider a Conversion. Once in the Roth, the money will grow tax-free, reducing your future RMDs from what is left in your Traditional IRA. We always prefer tax-free to tax-deferred.

Charitable Giving under the CARES Act

Congress also thought about how to help charities this year. Although RMDs are waived for 2020, you can still do Qualified Charitable Distributions (QCDs) from your IRA. And for everyone who does not itemize in 2020: You can take up to $300 as an above-the-line deduction for a charitable contribution.

Also part of the CARES Act: the 50% limit on cash contributions is suspended for 2020. This means you could donate up to 100% of your income for the year. This is a great opportunity to establish a Donor Advised Fund, if significant charitable giving is a goal.

Above the $300 amount, most people don’t have enough itemized deductions to get a tax benefit from their donations. Do a QCD. The QCD lets you make donations with pre-tax money. Of course, you could do zero charitable donations in 2020 and then resume in 2021 when the QCD will count towards your next RMD. But I’m sure your charities have great needs for 2020 and are hoping you don’t skip this year.

The Government was willing to forgo RMDs this year to help investors who are suffering large drops in their accounts. To have to sell now and take a distribution is painful. However, if you already took a distribution, you are not required to spend it. You can invest that money right back into a taxable account. In a taxable account, the future growth could receive long-term capital gains status versus ordinary income in an IRA. I’ll be reaching out to my clients this week to explain the 2020 CARES Act RMD rules. Feel free to email me if you’d like our help.

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Can You Reduce Required Minimum Distributions?

Posted On June 25, 2017 By Scott Stratton, CFP(R), CFA In Retirement Planning, Tax Strategies /   1 Comment

After age 70 1/2, owners of a retirement account like an IRA or 401(k) are required to withdraw a minimum percentage of their account every year. These Required Minimum Distributions (RMDs) are taxable as ordinary income, and we meet many investors who do not need to take these withdrawals and would prefer to leave their money in their account.

The questions many investors ask is Can I avoid having to take RMDs? And while the short answer is “no, they are required”, we do have several ways for reducing or delaying taxes from your retirement accounts.

1. Longevity Annuity. In 2014, the IRS created a new rule allowing investors to invest a portion of their IRA into a Qualified Longevity Annuity Contract (QLAC) and not have to pay any RMDs on that money. What the heck is a QLAC, you ask? A QLAC is a deferred annuity where you invest money today and later, you switch it over to a monthly income stream that is guaranteed for life. Previously, these types of deferred annuities didn’t work with IRAs, because you had to take RMDs. Luckily, the IRS saw that many retirees would benefit from this strategy and provided relief from RMDs.

Investors are now permitted to place up to 25% of their retirement portfolio, or $125,000 (whichever is less), into a QLAC and not have to pay any RMDs during the deferral period. Once you do start the income stream, the distributions will be taxable, of course.

For example, a 70 year old male could invest $125,000 into a QLAC and then at age 84, begin receiving $31,033 a year for life. If the owner passes away, any remaining principal will go to their heirs. (Source of quote: Barrons, June 26, 2017)

In retirement planning, we refer to possibility of outliving your money as “longevity risk”, and a QLAC is designed to address that risk by providing an additional income stream once you reach a target age. Payouts must begin by age 85. A QLAC is a great bet if you have high longevity factors: excellent health, family history of long lifespans, etc. If you are wondering if your money will still be around at age 92, then you’re a good candidate for a QLAC.

2. Put Bonds in your IRA. By placing your bond allocation into your IRA, you will save taxes several ways:

  • You won’t have to pay taxes annually on interest received from bonds.
  • Stocks, which can receive long-term capital gains rate of 15% in a taxable account, would be treated as ordinary income if in an IRA. Bonds pay the same tax rate in or out of an IRA, but stocks lose their lower tax rate inside an IRA. You have lower overall total taxes by allocating bonds to IRAs and long-term stocks to taxable accounts.
  • Your IRA will likely grow more slowly with bonds than stocks, meaning your principal and RMDs will be lower than if your IRA is invested for growth.

3. Roth Conversion. Converting your IRA to a Roth means paying the taxes in full today, which is the opposite of trying to defer taking RMDs. However, it may still make sense to do so in certain situations. Once in a Roth, your money will grow tax-free. There are no RMDs on a Roth account; the money grows tax-free for you or your heirs.

  • If you are already in the top tax bracket and will always be in the top tax bracket, doing a Roth Conversion allows you to “pre-pay” taxes today and then not pay any additional taxes on the future growth of those assets.
  • If not in the top bracket (39.6%), do a partial conversion that will keep you in your current tax bracket.
  • If there is another bear market like 2008-2009, and your IRA drops 30%, that would be a good time to convert your IRA and pay taxes on the smaller principal amount. Then any snap back in the market, or future growth, will be yours tax-free. And no more RMDs.
  • Trump had proposed simplifying the individual tax code to four tax brackets with a much lower top rate of 25%, plus eliminating the Medicare surtaxes. We are holding off on any Roth conversions to see what happens; if these low rates become a reality, that would be an opportune time to look at a Roth Conversion, especially if you believe that tax rates will go back up in the future.

4. Qualified Charitable Distribution. You may be able to use your RMD to fund a charitable donation, which generally eliminates the tax on the distribution. I wrote about this strategy in detail here.

5. Still Working. If you are over age 70 1/2 and still working, you may still be able to participate in your 401(k) at work and not have to take RMDs. The “still working exception” applies if you work the entire year, do not own 5% or more of the company, and the company plan allows you to delay RMDs. If you meet those criteria, you might want to roll old 401(k)s into your current, active 401(k) and not into an IRA. That’s because the “still working exception” only applies to your current employer and 401(k) plan; you still have to pay RMDs on any IRAs or old 401(k) accounts, even if you are still working.

We can help you manage your RMDs and optimize your tax situation. Remember that even if you do have to take an RMD, that doesn’t mean you are required to spend the money. You can always reinvest the proceeds back into an individual or joint account. If you’d like more information on the QLAC or other strategies mentioned here, please send me an email or give us a call.

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5 Tax Savings Strategies for RMDs

Posted On November 3, 2014 By Admin In Retirement Planning /  

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In November each year, we remind investors over age 70 1/2 to make sure they have taken their Required Minimum Distribution (RMD) from their retirement accounts before the end of the year.  If an investor does not need money from their IRAs, the distribution is often an unwanted taxable event.  Although we can’t do much about the RMD itself, we can find ways to reduce their taxes overall.

Clients who have after-tax contributions to retirement accounts often ask about which account they should take their RMDs, but it doesn’t matter.  The IRS considers IRA distributions to be pro-rata from all sources, regardless of the actual account you use to make the distribution. Whichever account you use to take the RMD, the tax due is going to be the same.

If all your contributions were pre-tax, your basis in all accounts is zero and you can ignore the comments above.  Note that you do not have to take a distribution from each individual account, even though each custodian is likely to send you calculations and reminders about your RMD for that account. All that matters is that your total distribution meets or exceeds the RMD for all accounts each year.

For investors taking RMDs, here are 5 steps you can take to reduce your income taxes:

1) Asset Location.   Avoid generating taxable income in your taxable accounts by moving taxable bonds, REITs, and other income generating investments to your retirement account.  This will keep the income from the investments out of a taxable account, leaving your RMD as your primary or only taxable event.  Placing stable, income investments in your IRA will also be a benefit because it will keep your IRA from having high growth.  Otherwise, if your IRA grows by 20%, your RMDs will grow by 20%.  (Actually more than 20%, since the percentage requirement increases each year with age).

Keeping stocks and ETFs in a taxable account allows you to choose when you want to harvest those gains and also allows you to receive favorable long-term capital gains treatment (15% or 20%), a tax benefit which is lost if those positions are held in an IRA.  Lastly, if you hold the stocks for life, your heirs may receive a step-up in basis, which is yet another reason to hold stocks in a taxable account and not your retirement account.

2) Charitable Donations.  If you itemize your tax return and are looking for more deductions, consider increasing your charitable donations.  And instead of giving a cash donation, donate shares of a highly appreciated stock or mutual fund and you will get both the charitable donation and you’ll avoid paying capital gains on the position later.

3) Stuff your deductions into one year.  Many investors in their 70’s have paid off their mortgage and it is often a “wash” between taking the standard deduction versus itemizing.  If this is the case, consider alternating years between taking the standard deduction and itemized deductions.  In the year you itemize, make two years of charitable donations and property taxes.  How do you do this?  Pay your property tax in January and the next one in December and you have put both payments into one tax year.  Do the same for your charitable contributions.  The following year, you will have few deductions to itemize and will take the standard deduction instead.

4) Harvest losses.  Investors are often reluctant to sell their losers, but selectively harvesting losses can save money at tax time.  Besides offsetting any capital gains, losses can be applied against ordinary income of up to $3,000 a year, and any leftover losses carry forward indefinitely.

5) Roth IRA.  If you don’t need your RMD because you are still working, consider funding a Roth IRA.  There is no age limit on a Roth IRA, so as long as you have earned income, you are eligible to contribute $6,500 per year.  If you qualify for a Roth, then your spouse would also be eligible to fund a Roth, even if he or she is not working.  Although the Roth is not tax deductible, the contribution does enable you to put money into a tax-free account, which will benefit you, your spouse, or your heirs in the future.

There is a “five year rule” which requires you to have a Roth open for five years before you can take tax-free withdrawals.  This rule applies even after age 59 1/2, so bear that in mind if you are establishing a Roth for the first time.

One additional suggestion: although you have until April 1 of the year after you turn 70 1/2 to take your first RMD, waiting until then will require you to have to take two RMDs in that year.  It may be preferable to take your first RMD in the year you turn 70 1/2, by December 31.

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