As part of the CARES Act, the requirement for older taxpayers to take required minimum distributions from their retirement plans was waived for 2020. This primarily was due to the anticipated drop in value for most investments as a result of the economic effects of the COVID-19 pandemic, which did not end up materializing. So, barring any extension of the 2020 moratorium by Congress, required minimum IRA distributions must resume for the 2021 tax year.
What Are Required Minimum IRA Distributions?
Required minimum Distributions (RMDs) are required distributions from qualified retirement plans and are commonly associated with traditional IRAs, but they also apply to 401(k)s and SEP IRAs. The tax code does not allow taxpayers to keep funds indefinitely in their qualified retirement plans. Eventually, these 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, then he or she may have to pay a 50% penalty on the amount that is not distributed but should have been.
When Am I Required to Take My RMDs?
If you turned age 70½ before 2020 or turned 72 in 2020, you are already subject to the RMD requirement and must take a distribution in 2021. If you turn 72 in 2021, you must begin taking RMDs in 2021. However, the first year’s distribution for 2021 can be delayed to no later than April 1, 2022. The downside to this means you would have to take two distributions in 2022, which may or may not be beneficial to your taxes.
How Much Am I Required to Withdraw?
The amount you are required to withdraw is based upon the value of your IRA account on December 31 of the prior year divided by the “distribution period” (your life expectancy), which generally is found in the Uniform Lifetime Table for the year of distribution. Historically, the Uniform Lifetime Table – created by the IRS – has remained unchanged. But beginning with distributions in 2022, the IRS has developed a new table that reflects a longer life expectancy. In addition to the Uniform Lifetime Table, there is a Joint and Last Survivor Table, which can be used when the spouse is the sole beneficiary and is more than 10 years younger than the IRA account owner (this will result in a smaller RMD).
If you have more than one IRA, the RMD for each one is figured separately, but you may add up all of the RMDs and take the total amount required for the year from any one or a combination of your IRAs.
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.
Are the Distributions Taxable?
Because traditional IRA contributions are tax-deductible, distributions from these IRAs generally will be fully taxable. However, in some circumstances, the taxpayer may have basis from nondeductible contributions. In these situations, a portion of each year’s IRA distributions will be nontaxable.
Another method to reduce your tax resulting from RMDs is to donate the RMD directly to charity. A taxpayer may donate up to $100,000 of his or her IRA funds to a charity by directly transferring the IRA funds via a trustee-to-charity transfer. In doing so, (1) the transfer counts toward the RMD requirement, (2) the amount transferred is not taxed as income, and (3) no charity deduction is claimed. An advantage of this provision is that a taxpayer can take the standard deduction and still benefit from the charitable donation. It also prevents the IRA distribution from being included in the taxpayer’s AGI; meaning it would not affect certain tax items such as the taxability of Social Security income and the cost of Medicare premiums.
Even though an IRA 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 could be liable for the under-distribution penalty, even if no income tax would have been due on the under-distribution.
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., and 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 taxes. If you need help with planning your required minimum IRA distributions, please contact Cray Kaiser.
Please note that this blog is based on tax laws effective in March 2021, and may not contain later amendments. Please contact Cray Kaiser for most recent information.