On March 27, 2020, the President signed into law the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”). As part of the CARES Act, required minimum distributions (RMDs) from IRAs and retirement plans, including 401(a), 401(k), 403(b) and governmental 457(b) plans, were waived for the 2020 calendar year. The CARES Act says you don’t have to take a Required Minimum Distribution (RMD) from your retirement accounts this year but should you?
The answers to two simple questions will give you a pretty good idea of what to do.
- Do I need my RMD to cover my living expenses? If you answer yes, then you should take (at least part of) your RMD.
- Will your tax bracket be higher in the future? If yes, then you still may be better off by taking (at least part of) your RMD. For example, you might be in a lower bracket because your spouse hasn’t yet started to receive Social Security or a pension, or because your spouse hasn’t reached the age where their RMDs begin.
If you answered "No" to both questions, then it’s likely that you should not take your RMD this year.
The CARES Act RMD Waiver
The premise behind the CARES Act RMD waiver is that most retirement accounts have declined significantly in value since the end of 2019. Because your 2020 RMD would be based on your December 31,2019 balance and your current balance is probably lower, your RMD would be a (much) higher percentage of your current balance. For example, for a 75-year-old, the RMD is 4.37% of the December 31, 2019 balance. If the balance has dropped from $100,000 on December 31, 2019 to $73,000 now, the $4,370 RMD would be 6% of the current balance — much higher than Congress or the IRS intended.
Even so, if you need the money, take the RMD. Distributions are not required, but they are certainly allowed. The CARES Act is designed to help people, not hurt them. However, because your retirement account balance has declined, you may decide that you should reduce your spending. You might then make a draw smaller than your RMD. In our example above, you might draw, say, $2,500 rather than $4,370, and there would be no penalty.
Can the Right RMD Strategy Increase Your Tax Savings?
If your tax bracket is lower than you expect it to be in the future, you don’t want to miss this year’s opportunity to draw money from your retirement account at an advantageous tax rate, even though no RMD is required. Suppose for example that you expect to be in the 12% Federal tax bracket this year, but in the 22% bracket later. You can save 10% on withdrawals you take this year. After tax, you’d net $3,846 this year on that $4,370 withdrawal we talked about before, vs $3,409 once you reach the higher bracket. In fact, you may want to draw more than your RMD – enough to take your income to the top of the 12% bracket, to maximize your tax savings.
Alternatively, you might decide to do a Roth conversion instead of taking a distribution. You could put the amount you choose to draw, in our example $4,370 (or even more – to take you to the top of your tax bracket), in a Roth IRA. Ideally, you’d pay the tax with money you have in a savings account or brokerage account, someplace other than the retirement account, to maximize the amount you can put in the Roth IRA. Now you’ve moved money from your retirement account to a tax-free account, at a low tax rate!
If you don’t need the money, and you don’t expect your tax bracket to be higher in the future, it’s probably best to skip the distribution for this year. The money you leave in your retirement account can continue to grow (we all hope!) tax deferred.
The CARES Act provides considerable flexibility for your retirement account distributions this year. Taking a little time to think through your options can help you make the best decision.
Please contact our office if you have questions or would like to discuss further.