For retirees, one of the beneficial features of the Coronavirus Aid, Relief, and Economic Security (CARES) Act is the waiver of required minimum distributions (RMDs) for 2020, even if you are unaffected by the coronavirus.
Retirees can avoid liquidating assets at low prices and can mitigate frightening drops in their account balances.
Retirees need to be proactive, 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.
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 the 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.
RMDs and Market Collapses
There are three problems with taking RMDs after the market has tanked:
- rapid drops in one’s account balance are worrying, 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.
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.
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 the 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.
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.
Individuals who are eligible to treat an RMD 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.
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.
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.