Contributed by: Kali Hassinger, CFP®
If you read through our CARES Act blog you may have noticed a brief mention of the fact that Required Minimum Distributions are suspended for 2020. This change applies to all retirement accounts subject to RMDs such as IRAs, employer-sponsored plans like 401(k)s, and 403(b)s, and inherited retirement accounts.
If you are among the fortunate who only take RMD withdrawals because they are required, the CARES Act presents a real financial planning opportunity for 2020! The reduction in your income provides some wiggle room to implement other tax, income, and generational strategies.
ROTH CONVERSION
Moving money from a tax-deferred account to a tax-exempt account like a Roth IRA is a great long-term strategy to consider. Typically, RMDs must be withdrawn from the retirement account before any additional funds are allowed to be converted.
Account holders could now, in theory, convert their typical RMD amount into a Roth. Your taxable income wouldn’t be any higher than you’ve most likely planned for this year and you get the benefit of the Roth tax treatment in the future. Roth conversions are especially favorable with accounts that will ultimately be inherited by children/family members who are in higher tax brackets or if your IRA balance is significant. The SECURE Act of 2019 changed the rules for inherited retirement accounts, they are no longer able to be stretched out over the lifetime of the beneficiary. Now, a beneficiary must withdrawal the entire account balance within ten years of inheritance. Distributing a tax-deferred retirement account in ten years, which has often taken a lifetime to accumulate, could create substantial taxable income for the beneficiary.
Roth funds, however, maintain their tax-free withdrawal treatment from generation to generation!
Keep in mind that, unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.
TURN ON OTHER INCOME
For many in retirement, managing income to remain consistent is an integral part of their financial plan. In years when income fluctuates up, taxes due and Medicare premiums can be negatively impacted. The suspension of RMDs provides the opportunity to act on some of the strategies that you may be avoiding because of the tax implications. Non-Qualified Annuity withdrawals, for example, are taxed on a last-in, first-out basis. That means that growth is assumed to come out first and is taxable as ordinary income (note: the taxation of annuitized accounts differs). If you’ve been holding off on accessing a Non-Qualified Annuity to avoid the additional tax, this year could be an excellent opportunity to make a withdrawal instead of taking your RMD!
HARVEST GAINS
We’ve seen our fair share of market losses so far this year, and harvesting investment losses is an effective tax reduction strategy. However, for those who aren’t taking RMDs this year, it could be an opportunity to harvest gains instead. It isn’t uncommon to hold onto long-term investments, not necessarily because they are still desirable, but to avoid the capital gain taxation.
If annual income is reduced by your RMD amount, there may be some wiggle room to lock-in those profits in a tax-efficient manner.
FILL UP YOUR TAX BRACKET
The Tax Cuts and Jobs Act of 2017 reduced income tax rates for many. If you are in a lower tax bracket now than you have been, historically withdrawing your Required Minimum Distribution amount (or more) may still be beneficial in the long term.
The Tax Cuts and Jobs Act of 2017 reduced income tax rates for many. If you are in a lower tax bracket now than you have been historically, withdrawing your Required Minimum Distribution amount (or more) may still be beneficial in the long term. For those who have already taken their RMD for the year and wish they hadn’t, there are some options to reverse the withdrawal. The most straight forward choice, if the withdrawal occurred within the last 60 days, is to treat it as a 60 days rollover & redeposit the funds. It’s important to remember that you are only allowed one 60 day rollover per year. If you’re outside of that 60-day window, however, there is a CARES Act provision that allows COVID-19 related hardship withdrawals to be repaid within the next three years. This provision is expected to be broadly interpreted, but we do not have clarity on whether this hardship provision will apply to RMDs.
Be sure to discuss the options surrounding RMDs with both your financial planner and taxpreparer. Any income and tax changes should be examined before making a decision. Many times, reviewing your financial plan and goals can be a helpful exercise in determining what strategy is best for you!
Kali Hassinger, CFP®, CDFA®, is a CERTIFIED FINANCIAL PLANNER™ professional at Center for Financial Planning, Inc.® She has more than a decade of financial planning and insurance industry experience.