One of the more beneficial features of the Coronavirus Aid, Relief, and Economic Security (CARES) Act for retirees is the waiver of required minimum distributions (RMDs) for 2020. The waiver applies even to those who are not at all affected by the coronavirus.
The waiver provides flexibility for those who can afford not to take retirement plan distributions. Retirees can avoid liquidating assets at low prices. They can also mitigate frightening drops in their account balances.
Retirees need to be on their guard, however. Plans can still make distributions that would have been RMDs, even though the law does not require it. Unwanted distributions can be rolled over, but as with any rollover there are strings attached.
Account-based retirement plans (such as 401(k)s and IRAs) must by law make required minimum distributions after the plan participant or IRA owner reaches a certain age. The aim is to make individuals use up their accumulated tax-favored savings during retirement rather than pass it on to the next generation. Distribution amounts for a year are based on the individual’s age during the year, and on the individual’s account balance at the end of the previous year.
The precise beginning age varies depending on the circumstances. Before the SECURE Act, individuals started RMDs the year they turned age 70 ½. For example, if someone turned age 70 ½ in 2018, that person would have to start taking RMDs for the 2018 tax year. The SECURE Act changed this age to 72 for individuals who attain age 70 ½ after 2019.
Comment: RMDs out of non-Roth accounts are fully taxable at ordinary rates, and they cannot be rolled over. The only tax-friendly way out is through qualified charitable distributions. Given the choice, retirees who can afford to not take distributions usually prefer to postpone them as long as possible.
There is an exception to this timing rule for employee plan participants who continue working past the year they turn age 72. These participants do not start RMDs from their employee plan until the year they are no longer an employee. Note this special treatment does not apply for individuals who own more than five percent of the employer. It also does not apply to that individual’s IRAs or other employee plans of other employers.
Grace period for one’s first RMD. Normally, RMDs must be taken by the end of the calendar year for which they are required. Individuals get a grace period for taking their first RMD, however. The required beginning date for the first RMD is April 1 of the following year. The grace period applies whether the individual is starting to take distributions at age 72, or after severing employment at an older age.
Comment: A person who uses the grace period is taxed in the year the distribution is made. A reason not to take advantage of the grace period is that the recipient has to take two RMDs in the same year. For example, if Mary has to begin RMDs for Year 1, and takes that distribution by April 1 of Year 2, Mary still has to take her Year 2 distribution by December 31 of Year 2. Mary may end up in a higher tax bracket because of bunched taxable income.
Caution: Employer plans and sometimes IRA arrangements take these mandatory distribution rules into account. Accordingly, unless a plan is written in a way that is sensitive to possible waivers, a plan’s own documents might force the plan administrator to keep making distributions that mirror the RMD requirements even if the rule is temporarily suspended. Plans can be amended retroactively and IRA administrators can be asked to stop making these distributions. But once they are distributed into the hands of the individual, they can be tricky to put back.
RMDs and Market Collapses
There are three related problems with taking RMDs after the market has tanked:
- rapid drops in one’s account balance is worrying all by itself especially for people living off of the account;
- this year’s 2020 RMD amount is based on last year’s account balance as of December 31, 2019, so the size of the RMD seems way out of proportion to the now diminished current balance; and
- expensive assets bought during a bull market need to be liquidated at seemingly give-away prices to fund current RMDs.
The last market collapse happened in 2008, after which Congress waived 2009 RMDs. That was largely the template for the 2020 waiver.
Waiver for RMDs Taken in 2020
Congress created the waiver for IRAs and employer account-based defined contribution plans, including 401(k) plans, tax-sheltered annuity plans, and eligible government deferred compensation plans. The waiver also covers inherited IRAs (including inherited Roth IRAs).
RMD Waiver and Required Beginning Dates
One difference between the 2020 waiver and the 2009 waiver is how they treat distributions of the previous year’s RMD during the grace period for first-time RMDs. The 2009 waiver did not cover grace period 2008 distributions made in 2009. The 2020 waiver, however, extends to any RMD distribution taken in 2020 including grace period distributions of 2019 first-time RMDs.
Comment: One could argue that the 2020 waiver rewards procrastinators who waited to take RMDs until the last minute. These people have essentially two waivers: one for 2019 and one for 2020. Note that the logic of this 2020 calendar-year approach to 2019 RMDs might suggest that an individual who must start taking RMDs for 2020 with a required beginning date of April 1 2021, must take 2020 RMDs once the calendar year ticks over to 2021. But that is not the case. All RMDs for the 2020 tax year are waived, including for those who have a grace period during 2021.
Comment: Note that an individual who would have to begin distributions starting for 2020 do not have to do so merely because the grace period spills over into 2021.
The waiver does not change the individual’s required beginning date for RMDs after 2020. For an individual whose required beginning date is April 1, 2021, the 2021 RMD must be made no later than December 31, 2021. If the individual dies on or after April 1, 2021, the RMD for the individual’s beneficiary will be determined using the rule for death on or after the individual’s required beginning date.
Comment: This means someone whose first RMD would have been 2020 with an April 1, 2021, grace period does not get a second grace period for their 2021 RMD.
For an individual who died and whose interest is required to be distributed within five years, the five-year period is determined without regard to calendar year 2020. For example, for an account with respect to an individual who died in 2018, the five-year period ends in 2024 instead of 2023.
SECURE Act and People Born in 1949
The SECURE Act moved the age for first-time RMDs from the year people turn age 70 ½ to the year they turn age 72. The cutoff for the change is people who turn age 70 ½ in 2019. That means someone with a birthdate on or before June 30, 1949, has to make RMDs in 2020. Those born from July 1 to December 31, 1949, do not have to take RMDs until they turn age 72 in 2021.
Comment: The 2020 RMD waiver now eliminates this disparity for people born in 1949.
The CARES Act RMD waiver does not provide any relief for someone who took distributions in 2020 thinking they were fulfilling their obligation to take RMDs. However, the CARES Act does allow anyone taking a distribution in 2020 to treat it as a coronavirus-distribution if they qualify. And distributions that qualify can be rolled over.
Comment: Individuals who are eligible to treat a distribution as a coronavirus-related distribution have up to three years to re-contribute the amount if they want to.
Rollovers. Eligible distributions can be rolled over if they otherwise qualify. An individual receiving an eligible distribution has 60 days to re-contribute the amount. Rollovers of eligible distributions can only be done once during any 12-month period. If the distribution was from an employer plan, 20 percent of the distribution must be withheld for income tax.
Employer plans making eligible distributions must notify participants in writing of their right to take the distribution in a “direct rollover” instead. Direct rollovers are transfers between plan trustees so recipients never deposit anything into their own bank accounts. The 60-day period requirement is irrelevant and does not apply. Neither does the once per 12-month period limit.
RMDs can never be rolled over into the recipient’s IRA or plan. Because of the RMD waiver, however, no distribution in 2020 is an RMD.
2020 Distributions and Rollovers
When talking about unwanted distributions, we are referring to actual distributions into the hands of a recipient rather than a direct trustee-to-trustee rollover into an IRA or other plan. Accordingly, both the 60-day and the once-in-12-months rules apply. If the distribution was from an employer plan, 20 percent tax must be withheld.
The IRS has extended the rollover deadline. Any 60-day period that ends on or between April 1 and July 14 is extended to July 15, 2020. Distributions taken as early as February 1, 2020, can be re-contributed as late as July 15.
Comment: January distributions were at least drawn from the liquidation of highly priced assets since that was the top of the market. Accordingly, there is less reason to fret about taking a distribution from that period. Bonus points for anyone who kept it as cash.
Plan Treatment of Distributions that Would Have Been RMDs
A distribution in 2020 that would have been an RMD but is instead an eligible rollover distribution is not subject to three requirements that normally apply to eligible rollover distributions. These include:
- the offer by the employer of a direct rollover instead of a distribution;
- written notice to the employee of the right to a direct rollover and the tax advantages; and
- mandatory 20-percent income tax withholding.
Example. An employer plan distributes an amount to Howard during 2020 that is an eligible rollover distribution but would have been an RMD. The plan’s normal obligations to offer Howard a direct rollover along with a written explanation, and withhold 20 percent are optional for the plan.
Comment: The option to take distributions that would have been RMDs from an employer plan through direct rollovers solves a number of rollover problems for retirees. Note that although plans are not required to offer it in 2020 for distributions that would have been RMDs, they are not prohibited from offering it. In any case, retirees should check with their plan to see what it intends to do about RMDs. The last thing someone needs is to find out what is happening through receipt of a check or automatic deposit into a bank account.
Retirees need to be proactive, because plans may still make distributions even though the law does not require it. Rollovers are a possibility, and the IRS has provided some timing relief. But retirees who want to avoid RMDs should find out how their plans intend to treat distributions that would otherwise have been RMDs. If the distributions are going to be made anyway, then a direct rollover is preferable.
By James Solheim, J.D.
Wolters Kluwer is by your side to help you stay up-to-date with tax and compliance changes and support your ability to work remotely. Please visit our Coronavirus (COVID-19) Resource Page for Tax & Accounting Professionals.