If you are age 72 or older, you generally must take required minimum distributions (RMDs) from your traditional IRA or employer-sponsored retirement plan, such as a 401(k) or 403(b), each year. These amounts are included in your taxable income, and if you fail to take your RMD by the annual deadline, the amount not withdrawn is taxed at 50 percent. However, as with many other areas of life, the rules are different this year.
The CARES Act—the massive stimulus package enacted in March with a goal of providing financial relief for individuals and businesses impacted by the COVID-19 pandemic—waived the requirement to take RMDs for 2020. Since the value of most retirement accounts declined sharply due to market volatility caused by the pandemic, the waiver was intended to let retirees recoup the losses in their accounts while the economy recovers. However, if you’re wondering whether you should take your RMD this year even though you’re not required to do so, read on to learn about some of the factors that may affect your decision.
You should take your RMD in 2020 if…
- You need the money to cover living expenses. If so, you have the option of taking the full amount of your RMD, or only part of it without penalty.
- You expect to be in a higher tax bracket in the future. Since your RMD is included in taxable income, you should consider your current and future tax brackets when deciding whether to take your RMD in 2020. For example, if your spouse has not yet begun receiving a pension or Social Security, you may jump to a higher tax bracket when he or she starts receiving those payments. In that case, you should probably take your RMD this year in order to draw down your retirement account balance while at a more advantageous tax rate.
- You want to avoid larger RMDs in future years. Your RMD amount is calculated by dividing your account balance on December 31 of the previous year by your life expectancy (as estimated by IRS tables). Therefore, RMDs will constitute a higher percentage of your account balance as you get older. If you do not take an RMD in 2020, there will be more money in your account in future years—and combined with the higher withdrawal percentage, you could find yourself in a higher tax bracket or even facing higher Medicare premiums. If you are concerned about this possibility, talk to a financial professional to help you determine how much, if any, you should withdraw from your retirement account this year.
On the other hand, if the above circumstances don’t apply to you, it’s probably best to avoid taking your RMD this year. Leaving the money in your retirement account will allow it to continue enjoying tax-deferred growth, which is particularly beneficial as the market is still experiencing volatility in the wake of the pandemic. In addition, by not taking an RMD, you can lower your taxable income for 2020.
Another option to consider if you don’t need your RMD to pay for living expenses would be withdrawing money from your traditional IRA or employer-sponsored plan and placing it in a Roth IRA. While you would pay taxes on the Roth conversion now, you can later withdraw it tax free. This may be particularly advantageous if you or your beneficiaries are likely to face higher tax rates in the future—and considering that federal income tax rates are scheduled to revert to their higher, pre-2018 levels by 2026, this will be the case for many taxpayers.
What if you have already taken an RMD in 2020?
According to guidance that the IRS issued in June, if you have taken a distribution from your retirement account at any time in 2020, you are permitted to return the amount to your account without having to pay income taxes on it.
While the RMD waiver provides needed flexibility for many retirees, there are several factors that may influence whether or not you should take an RMD in 2020. As the end of the year quickly approaches, now is the time to consult a financial professional to determine the optimal strategy for your unique circumstances. Contact our team today!
–Stephanie Vance, J.D.
(Sources: https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-required-minimum-distributions#4, https://www.kiplinger.com/article/retirement/t045-c032-s014-stay-on-top-of-rmd-rule-changes-for-2020.html, https://www.forbes.com/sites/rmiller/2020/05/21/should-i-take-my-rmd-this-year/#769409433f8c).
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