Required Minimum Distributions (RMD) are Back in 2021…For Now

Tax-deferred accounts are great while you are working.  You can receive a tax deduction for deferring income into retirement accounts like IRAs and 401(k), and you don’t even have to pay taxes when the accounts have interest, dividends, and capital gains.  However, the party has to end at some point, and for many taxpayers, the moment the record screeches to a stop is when Required Minimum Distributions (RMD) begin.

Just as the name infers, RMDs are a requirement to distribute, and therefore tax, a certain amount or more from a tax-deferred account each year.  The penalty for not distributing the RMD is half of the RMD amount.

The new age for RMDs is the calendar year that a taxpayer turns 72, although the first year of the requirement, you can elect to push back the date until April 1st of the following year.  The amount is calculated by dividing the previous year-end balance by a life-expectancy figure from IRS tables.  With each passing year, the life expectancy decreases, which means that the percentage of the account balance goes up.

In March of 2020, Congress passed the CARES Act, which suspended the RMD requirement for the 2020 tax year.  Eventually, they gave ample time for those who took their distribution before the bill was passed to return the funds to their retirement accounts and reverse the distribution.  However, this provision was only for 2020, and now the RMD is back for 2021.

Another subset of accounts subject to RMDs are retirement accounts that have been passed down to the heirs of the original account owners after their death.  These “Beneficiary IRAs” also have a requirement to be distributed regardless of the age of the beneficiary, but those rules a differ depending on when the original owner died.

If the original owner died before 2020, the beneficiary is required to distribute a portion of the IRA each year based on their age and life expectancy.  This allows the beneficiary to stretch the distributions over their lifetime.  If the IRA owner died after 2019, the beneficiary is not required to make a distribution each year, but they must have the entire account distributed within ten years of the death.  This ten-year clock starts ticking on Jan 1st of the year following the death.

The RMD only requires that the funds leave the account, but there are many options of where to move the funds. 

Here are some alternatives:

• Use the funds to support your retirement income.  This is a perfectly acceptable use of the funds. 

• Pay your taxes with the funds.  Instead of making quarterly estimated payments, you can elect to have taxes withheld from your RMD to cover your tax bill for the year.  You can even direct all of your RMD to be withheld for taxes if you like.

• Give part of your RMD directly to charity.  If this giving is done directly from the IRA, it is considered a Qualified Charitable Distribution (QCD) and will not be counted as income on your taxes. However, QCDs do count towards your RMD, and you can even go beyond the RMD amount.  The annual limit on QCDs is $100,000 per year per IRA owner.

• Move the funds to an after-tax brokerage account and reinvest the funds.  The IRS doesn’t require that you spend the money, just that it leaves your IRA.  If you don’t need the funds, you can reinvest them in a different account.

Our new Congress has indicated that they would like to pass an additional stimulus package this year. Repeating the waiver of the RMD requirement in 2021 would likely be on the table.  While predicting upcoming legislation is incredibly difficult, you may consider holding off on your 2021 distributions until the process plays out.