David T. Mayes
After a short period provided by the CARES Act, owners of tax-privileged retirement accounts will have to include the required minimum distributions (RMDs) in their tax planning for 2021 again. In order for those accounts to have some post-market wiggle room to recover due to the decline triggered by the COVID-19 pandemic, the CARES Act waived these mandatory withdrawals for all retirement accounts, including those inherited from non-spouse beneficiaries were. With this planning for 2021, keep in mind that there have been some other legislative changes and updates to the life expectancy tables recently that go into the RMD math. Here’s a quick refresher on these new rules.
First, let’s start with what types of accounts are mandatory to withdraw. Traditional IRAs, employer-sponsored retirement plans such as 401 (k) s, 403 (b) s, and the federal government’s savings plan, and SIMPLE and SEP IRAs are governed by the RMD rules. Roth IRA accounts are not subject to RMDs for the original owners. However, Roth 401 (k) accounts must follow the same rules as pre-tax deposits for these employer plans. However, these RMDs can be avoided by rolling the Roth 401 (k) into a Roth IRA after leaving the employer. Additionally, non-spouse beneficiaries who have inherited Roth IRAs from their original owners must make the necessary withdrawals from those Roth accounts.
For original account holders and beneficiaries, the rules for starting RMDs have changed. The SECURE Act of 2019 raised the RMD age for account holders from 70½ to 72 years. That means people who were under 70½ by the end of 2019 can wait to receive their first RMD for the year in which they celebrate their 72nd birthday. In other words, the 70½ year rule applies to anyone born before June 30, 1949, while retirees born on July 1, 1949 can delay until the age of 72. However, the first RMD is not due until April 1 of the year after the age milestone is reached. If this leeway is used, two RMDs must be claimed in the following year, which can temporarily drive the pensioner into a higher tax bracket. Subsequent RMDs must be completed by December 31 of each year.
The amount of each RMD is calculated by dividing the financial statements of the account that requires mandatory withdrawals by an IRS prescribed life expectancy factor. The IRA and 401 (k) custodians calculate RMD amounts annually for original account holders, but not for inherited accounts. The consequence of withdrawing less than the required amount will be an “Excess Accumulation Penalty” equal to 50% of the missed RMD amount. For example, an IRA owner who was subject to an RMD of $ 30,000 but withdrew only $ 10,000 during the year would receive an additional tax charge of $ 10,000.
Whether beneficiaries who have inherited IRA or Roth IRA accounts are required to receive a dividend in 2021 depends on when the account was inherited. If the original account holder passed away in 2019 or earlier, most beneficiaries will make distributions based on the life expectancy rule and will make a payout for each year following the year of the original account holder’s death. In this situation, a withdrawal is required for both inherited traditional IRA and Roth IRA accounts in 2021. Accounts inherited from owners who passed away in 2020 may not need to be withdrawn for 2021 as SECURE law now requires most non-spouse beneficiaries to retire inherited accounts within ten years rather than during have to empty their lives. This means that withdrawals can be made every year or fully delayed up to the 10th year after the original owner’s death. Non-spouse beneficiaries who inherit sizeable pre-tax retirement accounts should conduct careful multi-year tax planning to determine whether it makes sense to spread the withdrawals over the 10 year period or make larger withdrawals in years when their income may be is lower.
Finally, remember that RMDs cannot be transferred to another retirement plan in order to delay the tax stroke. 2020 was an exceptional year that some retirees who took their RMDs early to have them reclassified as regular withdrawals under CARES law were able to re-deposit those withdrawals into an IRA (or convert them to a Roth IRA )). Remember that without an RMD waiver, an RMD cannot be returned to a retirement account.
David T. Mayes is a Certified Financial Planner and IRS Enrolled Agent at Three Bearings Fiduciary Advisors, Inc., a Hampton fiduciary financial planning firm. He can be reached at (603) 926-1775 or firstname.lastname@example.org.