Ok folks, this one’s pretty long. Here’s the tldr: RMD’s were postponed in 2020, they’re not in 2021. You MUST take your RMD in 2021. Make sure you do! Brave souls only, read on past this point!
When Congress established tax-favored retirement plans, they allowed taxpayers to take a tax deduction for the amount of their allowable contribution to the plans. But they also included a requirement for a portion of the funds to be distributed each year and be subject to income tax. Such a distribution is referred to as a required minimum distribution (RMD).
RMDs are commonly associated with traditional IRAs, but they also apply to 401(k)s, SEP IRAs and other qualified retirement plans. The tax code does not allow taxpayers to keep funds in their qualified retirement plans indefinitely. Eventually, assets must be distributed, and taxes must be paid on those distributions. If a retirement plan owner takes no distributions, or if the distributions are not large enough, he or she may have to pay a 50% penalty on the amount that is not distributed.
There is no maximum limit on distributions from a Traditional IRA, and as much can be withdrawn as the owner wishes. However, if more than the required distribution is taken in a particular year, the excess cannot be applied toward the minimum required amounts for future years.
There have been some recent tax law changes that have led to some confusion among taxpayers subject to the RMD requirement. Prior to 2020, the required starting age for RMDs was 70½. Thanks to the Secure Act passed by Congress in late December 2019, the age at which distributions have to begin was increased to age 72 starting in 2020.
However, as part of the 2020 COVID relief, Congress suspended the RMD requirement. Thus those turning 72 in 2020, and those who turned 70½ in prior years, were not subject to the RMD requirement for 2020.
RMDs Resume in 2021 - Since the suspension was for one year only, the RMD requirement resumes for 2021. Of course, the resumption applies to those that attained the age of 70½ in years before 2021, those who turned 72 in 2020 and those who turn 72 in 2021.
Still Working Exception – If you participate in a qualified employer plan, generally you need to start taking RMDs by April 1 of the year following the year you turn 72. This is your required beginning date (RBD) for retirement distributions. However, if your plan includes the “still working exception,” your RMD is postponed to April 1 of the year following the year you retire.
This delayed-until-retirement distribution provision does NOT apply to IRAs, so even though someone age 72 or older with an IRA is still working, and perhaps still contributing to the IRA, they are required to take a minimum distribution from the IRA each year.
First Year IRA RMD Exception – If a taxpayer so chooses, he or she can delay an RMD for the first year an RMD is required until the second year, thus making the distribution includible in the second year’s tax return. This is sometimes desirable if the taxpayer has substantial wages or other income in the year the mandatory distribution age is reached and expects less income the next year. In this situation, by delaying the distribution to the second year the tax bracket could be substantially lower. If the taxpayer chooses that option, then:
• The first year RMD must be taken by April 1 of the following year, and
• The taxpayer must also take the second year RMD distribution by December 31 of year two, thus doubling up the distributions in year two.
Determining the RMD Amount - The required withdrawal amount for a given year is equal to the value of the retirement account on December 31 of the prior year divided by the life expectancy (“distribution period”) from the Uniform Lifetime Table illustrated below, with the exception where the taxpayer’s spouse is 10 years younger, in which case the Joint and Last Survivor Table is used. It is not illustrated because of its size.
Note: the above table is only valid through 2021. The IRS has released a new table which must be used for the RMD computations beginning for 2022 and subsequent tax years.
Example: An IRA account owner is age 75 in 2021, and the value of his only IRA account was $120,000 on December 31, 2020. His 73-year-old wife is the sole beneficiary of the IRA. From the uniform lifetime table, we determine the owner’s distribution period to be 22.9. Thus, his RMD for 2021 is $5,240 ($120,000/22.9). That amount must be withdrawn by no later than December 31 of 2021.
If the same set of facts were to occur for a different taxpayer in 2022, using the new table (not illustrated), the distribution period will be 24.6 and the RMD $4,878 ($120,000/24.6). The new table was designed to take into account individuals’ longer life expectancies based on actuarial statistics developed since the last time the tables were updated. Thus, the comparable RMD is less than under the current table, and at least in theory, the IRA won’t be depleted as quickly.
The RMD for the year can be taken from any one or several of the taxpayer’s IRA accounts, but the minimum distribution amount must be figured separately for each account, and then totaled to determine the RMD for the year.
Caution: Some individuals roll over their distribution in the mistaken belief they can circumvent the RMD requirement. This is not true – remember, the purpose of the RMD is to force taxable distributions.
If the taxpayer dies prior to taking the entire RMD for the year of death, the IRA beneficiaries are responsible for figuring the owner's required minimum distribution in the year of death and distributing it to the named beneficiaries. If there are no beneficiaries, the distribution goes to the decedent’s estate
Excess Accumulation Penalty – The tax law includes a penalty referred to as an excess accumulation penalty. This draconian penalty is 50% of the RMD that should have been distributed for the year and wasn’t. In the preceding example, if the taxpayer does not withdraw the $5,240 for 2021, he would be subject to a 50% penalty (additional tax) of $2,620 ($5,240 x 50%).
Under certain circumstances, the IRS will waive the penalty if the taxpayer demonstrates reasonable cause and makes the withdrawal soon after discovering the shortfall in the distribution. However, the hassle and extra paperwork involved in asking the IRS to waive the penalty makes avoiding it highly desirable; to do so, always take the correct distribution in a timely manner. Some states also penalize under-distributions.
Even though a qualified plan owner whose total income is less than the return filing threshold is not required to file a tax return, he or she is still subject to the RMD rules and can thus be liable for the under-distribution penalty even if no income tax would have been due on the under-distribution.
Qualified Charitable Distribution – A taxpayer is allowed to transfer funds from their IRA to a qualified charity and the distribution is non-taxable. To constitute a qualified charitable distribution (QCD), the distribution must be made:
(1) Directly by the IRA trustee to a qualified charitable organization other than a private foundation or a donor-advised fund, and
(2) On or after the date the IRA owner attains age 70½. A distribution from an IRA made to a charitable organization in the year that the IRA owner turns 70½ but prior to the date the individual reaches age 70½ is not a qualified charitable distribution.
For those 72 and older a QCD will also count towards the annual RMD requirement. However, after 2019 the restriction on making traditional IRA deductions after age 70½ was repealed and Congress added a complication to QCDs. That provision requires the non-taxable portion of a QCD to be reduced by any deductible IRA contribution made after reaching age 70½.
Example – Bob makes a traditional IRA contribution of $7,000 when he is age 71 and another $7,000 contribution at the age of 72 and deducts the IRA contributions on his returns. Then later when he is 74, he makes a QCD in the amount $20,000 to his church’s building fund. Since Bob had made the deductible IRA contributions after age 70½, his QCD must be reduced by the $14,000. As a result, of the $20,000 QCD, $14,000 is a taxable distribution and only $6,000 is nontaxable. However, because the $14,000 was taxable Bob can claim a $14,000 charitable contribution if he itemizes his deductions. In addition, the entire $20,000 will count towards his RMD for the year.
Designated Beneficiaries - Keeping your designated IRA beneficiary or beneficiaries current is very important. You may not want your account going to your ex-spouse, and you certainly do not want a deceased individual to be your beneficiary.
In many cases, advance planning can minimize or even avoid taxes on Traditional IRA distributions. Often, situations will arise in which a taxpayer’s income is abnormally low due to losses, extraordinary deductions, etc., where taking more than the minimum in a year might be beneficial. This is true even for those who may not need to file a tax return but can increase their distributions and still avoid any tax. If you need help with the tax consequences of planning your RMD, please call this office for assistance.
As always folks, this post is educational and informational only. Don’t take advice from the internet. Ask your own tax pro or financial advisor for specific information about your situation.