Major changes in RMDs and retirement contributions in $2T stimulus plan
In addition to the catastrophic health situation caused by the new coronavirus, many of your clients are likely hurting financially, especially in their retirement accounts. Here’s how you can help them take advantage of several new relief provisions found in the $2 trillion CARES Act.
Extended IRA contribution deadline
As the Treasury has extended the tax return filing date to July 15, 2020, from April 15, 2020, the date for making 2019 IRA and Roth IRA contributions for 2019 is extended to the revised date.
Now is a good time for advisors to ask clients whether they plan to take advantage of this extension. Because clients’ financial situations may have taken a turn for the worst due to a job loss or business downturn, even those who make IRA contributions each year might want to hold off and take advantage of the extra time to contribute.
Advisors should also be careful to monitor any 2019 IRA contributions made after April 15, 2020. Custodians may automatically code 2019 IRA contributions as 2020 contributions if made after April 15. Make sure these checks state that they are for 2019 and then follow up with the custodians to confirm that the contributions are posted correctly.
In addition to IRAs, the extended deadline applies to contributions for the 2019 Health Savings Account, Archer Medical Savings Account and Coverdell Education Savings Account.
RMDs waived for 2020
Included in the massive bill are several relief provisions for retirement accounts. The one that will affect most retirees is the waiver of RMDs for 2020.
This will be a huge help because 2020 RMDs would generally be based on the substantially higher account values on Dec. 31, 2019. If not for this relief, IRA owners would be forced to pay tax on a much higher percentage of their IRA balance. Eliminating the RMD for 2020 can help clients reduce their 2020 tax bill. However, this won’t help those clients who need the funds and must take withdrawals anyhow.
The RMD waiver also applies to 2019 RMDs that are normally due by April 1. In another bit of positive news, the waiver applies to IRA owners who turned 70 ½ in 2019. The Secure Act had increased the RMD age to 72 for those who turn 70 ½ in 2020 or later. Those who turned age 70 ½ in 2019 were still required to take their first RMD by April 1, 2020. Not anymore.
When clients begin taking RMDs, they have an option of taking all or part of the first year distribution in the year they turned 70 ½ (under pre-Secure Act rules) or deferring any part of that RMD until April 1 of the following year. If they wait until the following year, they must take their first two RMDs in the following year, resulting in a bunching of RMD income in the same year and an increased tax bill.
To alleviate this situation, we have often advised clients to take their first RMD in their 70 ½ year so they can spread the income from their first two RMDs over two tax years. Unfortunately, if they took this advice last year, they won’t benefit from the RMD waiver for their first RMD, as they already took that in 2019. Their 2020 RMD, though, is waived. Clients who didn’t listen to us and deferred their first RMD to 2020 may now be able to have their first two RMDs waived.
A less-obvious group that can benefit from this waiver are IRA beneficiaries who inherited in 2015 or later and who are subject to the five-year payout rule. Generally, this only applies to non-designated beneficiaries who inherited before the deceased IRA owner reached his required beginning date (April 1 following the age 70 ½ year).
These beneficiaries may have inherited through a will or were a beneficiary of a trust that did not qualify as a designated beneficiary. For example, for IRAs inherited in 2015, under the five-year rule, any balance remaining in the inherited IRA would normally have to be withdrawn as the RMD for 2020. Beneficiaries now have one more year, until Dec. 31, 2021, to empty the account. For beneficiaries who inherited in 2015, the five-year rule becomes a six-year rule.
Undoing RMDs already taken?
One question is whether 2019 or 2020 RMDs already taken in 2020 can be put back in the IRA so the tax bill is eliminated. The relief package does not include any repayment provisions, so the IRS may have to issue guidance on this issue. There may be a way for some clients to undo 2019 or 2020 RMDs already taken this year, but only under these three conditions:
- Rollovers are not an RMD. An RMD cannot be rolled over. However, because the new law waives RMDs for 2020, then, technically, an RMD already taken is not an RMD anymore. This means it should be eligible to be rolled back into the IRA, thereby eliminating the tax bill. It’s likely the IRS will rule these distributions are not RMDs and are eligible to be rolled over, but only if they pass the next two tests.
- The 60-day rule must be followed. To be eligible for the funds to be rolled back to an IRA, the rollover must occur within 60 days of receipt of the funds. Those who took RMDs very early in the year may have already missed this window, but many clients may still have this opportunity available to them if they pass the third test.
- Clients must adhere to the once-per year IRA rollover rule. Only one IRA to IRA or Roth IRA to Roth IRA can be done per year, and that year is 365 days, not a calendar year. If another distribution is taken during the 12 months prior to receipt of the RMD that was already rolled over, the rollover option is off the table for the now unnecessary RMD distribution, even if the other two tests are passed.
Although the RMD waiver applies to inherited IRAs, the ability to undo RMDs already taken would not be available for non-spouse IRA beneficiaries, as they cannot do 60-day rollovers.
If all or part of the RMD was transferred to a charity as a qualified charitable distribution, then there’s no problem, because that amount is excluded from income anyway.
Once an IRA owner reaches age 70 ½, they can still do a QCD whether or not they are subject to RMDs.
Additional relief provisions
The new act waives the 10% early distribution penalty on up to $100,000 of 2020 distributions from IRAs and company plans for “affected individuals.” The tax would be due, but could be spread evenly over three years, and the funds could be repaid over the three-year period.
While the 10% early distribution penalty is waived, the amount withdrawn is still subject to tax, and it removes funds that may be needed for retirement. Thus, this option should be used only as a last resort.
We’ve seen this provision in previous disaster relief bills, but that relief only applied to people affected by a particular hurricane, wildfire or other type of disaster. Here, given the scope of the current pandemic, “affected individuals” could include a great many people so plans should brace for an onslaught of hardship requests.
For those over age 59 ½, the 10% early distribution penalty is not an issue, but for those facing financial hardship, the ability to take a distribution now and spread the taxes over three years may be helpful.
If their situation improves, the opportunity to repay the funds during the three-year period could be a useful way for them to rebuild otherwise lost retirement savings.
Increasing plan loans
Finally, the new law affects company plan loans that may be taken by affected individuals.
First, the new law doubles the maximum amount of plan loans to the lesser of $100,000 (reduced by other outstanding loans) or 100% of the account balance.
This rule applies to loans that are taken within 180 days from the bill’s date of enactment. Second, any loan repayments normally due between date of enactment and Dec. 31, 2020, could be suspended for one year.
Advisors must be ready to answer lots of questions about these new provisions as they will impact virtually all clients. The pandemic and its economic fallout will result in many of your clients needing you more than they ever have.