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Commentary

Congress to Help Retirees Cope With Market Downturn

Stimulus bill includes provision that suspends required minimum distributions for retirement accounts.

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Congress will soon pass a major relief bill to help workers, retirees, and businesses cope with the coronavirus-caused economic slowdown. Among the provisions is a suspension of required minimum distributions, or RMDs, for 2020. That’s welcome relief for retirees.

Congress’s RMD suspension is similar to the relief in the Worker, Retiree, and Employer Recovery Act of 2008, which helped retirees cope with that financial market downturn.

But instead of passing emergency suspensions every time the market crashes, Congress should write in a permanent relief valve.

How RDMs Work Amid Market Turmoil
When markets crash, particularly shortly after the new year as they have during this crisis, retirees are faced with needing to take assets out of tax-sheltered retirement accounts based on high year-end valuations while the actual money in their accounts has shrunk considerably. If retirees were to take their RMDs out of their IRAs and 401(k)s, it could take a long time for these accounts to recover--if they recovered.

To be clear, an RMD does not force retirees to pull any money out of the financial markets--just tax-sheltered accounts. Retirees can withdraw assets from their defined-contribution plans and simply repurchase the same assets in a brokerage account. For assets in IRAs, retirees can often move these assets to a taxable account without selling them.

However, despite this reality, many retirees will sell their assets and put them in a cash position. Retirees may not understand that they have other options or may not have the fortitude to maintain a position during market turbulence. And RMDs send a signal that they should sell their assets. Further, even retirees who understand their options need to come up with the money to pay the taxes on RMDs even if they are willing to keep them invested, and that money will likely come from selling assets.

A Longer-Lasting Solution Is Needed
A permanent relief valve on RMDs would provide more certainty for retirees planning their withdrawals, and help stabilize financial markets, all while costing the federal government relatively little in forgone revenue. Such a permanent relief policy could be based on broad U.S. stock market downturns of around 20% from the previous year’s high. (Any number will be somewhat arbitrary, but this level would mean the relief only went into effect during major market events.) That would mean that Congress wouldn’t need to reauthorize the freeze on RMDs each time the market entered a major downturn; it would be automatic.

As I have argued before, RMDs are an important part of the retirement system. A tax-deferred system is not meant to delay taxes indefinitely. But as Congress keeps recognizing during downturns, it should not signal to people to empty their accounts during the worst times to sell if they do not need to. Rather than relying on Congress to act every time the financial markets significantly decline, Congress could assuage retirees’ fears and help them plan by codifying this relief.

An added benefit to this automatic RMD relief policy would be to add some stabilization to financial markets. If retirees were forced to take RMDs, they might try to make good decisions for them personally with bad outcomes for the market as a whole. First, many might wait out the year to see if markets improve. That strategy could mean millions of retirees taking out assets altogether late in the year to avoid an excise tax, further destabilizing financial markets. Similarly, retirees might all try to drawdown safer assets such as bonds to avoid selling equities low, increasing supply for these assets and causing them to decline in value. As the defined-contribution system matures, these issues will become more and more important and will be even more salient during the next market downturn. Again, account owners could simply move these assets to taxable brokerage accounts, but many will not.

Arguments About RMD Suspensions
While there are no official, public estimates of the costs of suspending RMDs this year just yet, the estimates of the cost of suspending them in 2009 in the Worker, Retiree, and Employer Recovery Act provide some insights. These suspensions reduce federal revenue on the order of a handful of billions of dollars and even produce some extra revenue a few years later. Depending on how fast markets recover, these suspensions could even be revenue-positive over a 10-year period.

Finally, a criticism of these RMD suspensions is that they don’t target people who really need the money, because being able to skip withdrawals from a retirement account is a luxury enjoyed only by those retirees with other sources of income or large cash reserves. That’s certainly true. However, even if you do not buy any of the other arguments for a suspension, it’s better to calm nervous retirees than not. Furthermore, since Congress’ reaction is to suspend RMDs, it will become an expectation and create even more consternation if a future Congress does not act.

Congress should mandate a permanent relief valve and avoid suspending RMDs in an ad-hoc fashion in the future. For the present, millions of retirees will be glad to have more flexibility as they navigate 2020.