RMDs Aren't Required for 2020. What Should You Do?

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Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Retired investors will be able to put their required minimum distributions on hold for 2020. Joining me to discuss what that means for retirees is Tim Steffen. He's an Advisor Education Consultant for Pimco. Tim, thank you so much for being here.

Tim Steffen: Great to see you again, Christine.

Benz: Great to see you too. So let's delve into this, starting with the suspension of RMDs. What's the thinking behind Congress putting RMDs on hold for this year?

Steffen: Well, I think people were concerned about being forced to take money out of their retirement plans at a time when asset values are lower, accounts have been beaten up there for a period of time due to the market volatility we've seen. So I think it was just an idea: Let's let people leave their assets alone. Certainly, if you need to take money out, if you want to take money out, you can. But the fact that they were forcing people to take out money in perhaps a pretty rough market, they decided to just give people some flexibility. We've seen these kinds of things before. We've had significant volatility like this where they've waived RMDs and given you some flexibility for those who do want to take money out, and maybe even take more out. They've given you some flexibility and able to avoid some of the taxes and penalties on those things too. So they kind of give you flexibility on both ends in these situations.

Benz: And part of the idea too was I know that balances were really inflated at the end of 2019 and the RMD amount for 2020 would have been based on 2019 year-end balances.

Steffen: Right. The good news is we're coming off a great year in the market where account values were pretty inflated and it actually started off pretty well in 2020, too. But the RMD numbers are going to be, in terms of a percentage of your current balance, could have been pretty steep. So this is a nice benefit they gave everybody or the retirees for that.

Benz: So this applies to anyone who would have been subject to RMDs, essentially, so even people who inherited IRAs. It's really a very broad suspension of RMDs, correct?

Steffen: It really is. In fact, it was so broad, they even threw in one that nobody really expected, and that is people who turned 70 and a half in 2019 didn't have to take their RMD for that year until April first of this year. If those people deferred it, those RMDs are waived as well. So really, anybody who turned 70 and a half in 2019 might've been able to waive two RMDs--not just the one for this year.

The flip side of that though, is not every single account was able to waive the RMDs. There's one kind of unique account. If you have a 457 plan, that's a nongovernmental plan, usually those are typically issued by state employees or something like that, or federal employees. If you have a nongovernmental 457 plan, you do still have to take an RMD for this year. If you've annuitized an annuity, you have to continue to take that. If you're on a 72(t) program, you have to continue to take those distributions or you could end up blowing your 72(t). But for the most part, the RMDs are going to be our way for most individuals, most retirees, including, as you said, the beneficiaries of inherited accounts as well.

Benz: So conventional tax-planning wisdom is that I should delay any tax bill that I possibly can if I can. So does it seem like most people will want to avoid taking money out of their IRAs if they can afford to?

Steffen: It sure feels like it. You hear from a lot of retirees that they don't like to take RMDs because they don't want to have to pay the tax liability. They'd rather push that off down the road. So any time the government says you're required to do something, people are going to push back on it. So the flexibility they've given now to say, "Well, you're not required to. You certainly can if you want and we'll even give you a little bit of breaks with some of those here if you chose to do that, but you're not required to." So yeah, I think there's going to be a fair amount of people who will take advantage of that. Now the flip side of that, of course, is you've got people whose income situations are much different this year. You got somebody who was older but continuing to work. Maybe they're not able to work now, so they may need to take those distributions out of the IRAs anyways. They're not required, but they might be doing it anyways.

Benz: Let's talk about people who already took their RMDs. There's been a lot of confusion about this. Some people do like to take their early RMD so they don't forget. What are their options at this point?

Steffen: Yeah. A lot of people wait to take their RMDs until the end of the year and leave the money in the IRA as long as possible. Others say, "I'm going to take it on a pro rata basis to kind of dollar-cost average my way out during the year." So the people who start with their RMDs right in January or February were caught off-guard by this. So all of a sudden they were told, "Those distributions you took, you didn't have to do that anymore."

There's some opportunities to return that money back to the account. The main one is what we call the 60-day rollover. This has been around for a long time. And anybody who takes money out of a retirement account has 60 days to put that money right back into the same account or a similar-type retirement account, and it's treated as if you didn't take the distribution. Some limitations on that, the big one being you can only do that once every 365 days. So somebody who had already done one maybe later in 2019 isn't eligible to take advantage of that this year. But if you had not done one of those, you could do that 60-day rollover. The trick is it's a pretty tight 60 days. There's not often a lot of flexibility with that. They did offer up one form of flexibility, which we can get to. But in general, if you're on day 61, you're probably not going to be able to put that money back, at least under the traditional rules.

They did create a little bit of flexibility on that, though. As part of the whole delaying of tax returns and kind of all tax things that were due in April, they also threw in a little bone for people who had taken retirement plan distributions. What they said is that if your 60-day window ended on April first or later, that 60-day deadline gets extended to July as well. What that ultimately means is anybody who took money out of their retirement plan since February first really doesn't have 60 days, they've got until July to put that money back into the retirement account. So the 60-day thing was still there for people who took money out in January and got it in there quickly enough after the rules changed. It was actually pretty good flexibility for people who took money out in February or later. And then there's a couple of other things we can get into, too, on the distributions related to some of the CARES Act things, but that's the big one is the 60-day thing.

Benz: Let's talk about some tax-planning strategies for retirees who find themselves in this situation where they don't necessarily need their RMDs. They may potentially be able to take advantage of that opportunity to maybe be in a temporarily lower tax bracket. What strategies should they be considering? I know Roth IRA conversion, so converting traditional IRA assets to Roth, has been floated out there as potentially something to consider. Let's talk about that and any other strategies for tax-saving due to being in a temporarily low tax bracket.

Steffen: Yeah. So for a lot of retirees, the RMD may be their biggest source of taxable income. You take that off the table, now their taxable income drops dramatically. Now they may still have to pull some of that money out, they just may not meet the full RMD for this year. So they'll still have some taxable income. But they may find themselves still at a lower bracket than they otherwise would have been. You can take advantage of that now. The big one, as you said, is Roth conversions, the idea of taking money out of your traditional IRA, paying tax on it, and immediately moving into it into a Roth IRA where it can grow tax-free for the rest of your life.

That technique is fully available for anybody. They got rid of the income limits many years ago. So if you're someone who finds yourself in a lower tax bracket than you otherwise might find yourself in, that may be something to take advantage of. You could convert those dollars at a tax rate that you might not otherwise have ever been able to get into. It also has the added benefit of, once that money's out of the traditional IRA into the Roth, your future RMDs from the traditional IRA are now going to be lower because the base is lower in that account. So it gives you kind of a double benefit: tax-free growth going forward plus smaller RMDs into the future.

Benz: Now, realizing taxable capital gains at a lower rate might be another idea. So apart from what's going on with your IRAs, maybe looking at your taxable accounts if you have big gains in those accounts maybe, and you wanted to reduce some of those positions? This might be a good year to do that, too?

Steffen: You probably don't have a lot of gains that have generated during 2020, but you might've brought some gains into this year that are still out there that you may want to as you're thinking about rebalancing and diversifying the portfolio a little bit. You remember there's a tiered structure on capital gains, just like ordinary income. You've got a 0% rate and a 15% and a 20%. If you find yourself without the RMD, you can get yourself below that breakpoint for the 0% capital gains, and for a married couple that would be capital gain or income of about $80,000. If you're below that $80,000 threshold, you can recognize gains up to that amount and not have to pay tax on them. So let's say you've got $50,000 of other income, you could have $30,000 of gains you realize at a 0% rate. Or you might be somebody whose normally in the 20% or even the 20%--you have that 3.8% Medicare tax you have to deal with. Now you might find yourself outside of that or below those thresholds realizing gains. While still not tax-free, you might still be at the 15% rate, still a lot lower than what it might have otherwise been. And for people who were reluctant to sell things because of the taxes, this may be that little extra push that they need to rescue their portfolios back in line after everything else that's happened these last couple of months.

Benz: I want to talk about qualified charitable distributions. For a lot of investors, they kind of go hand in hand with required minimum distributions. Even though RMDs are on hold, you can still do the QCD. Let's talk about the advantage of doing that, Tim, in a year when you're not required to take any money out of your IRA at all.

Steffen: Sure. So just to recap, qualified charitable distributions, that's that direct distribution from your IRA to a charity. They've always been tied to RMDs because they happen to be at the same age that you could do it. You had to be 70 and a half. And you could use that towards your RMD. One of the big things that came out of the SECURE Act from earlier or later last year is that when they bumped the RMD age up to 72, they kept QCDs at 70 and a half. So you've got this period of time, this couple calendar-year window where you could take IRA distributions, give them right to charity, and not have to count them or it wouldn't even be part of your RMD. It'd just be a way to start diversifying out of your IRA or liquidating it down.

And that can still make sense for folks. We see that a lot, especially these days, after the tax cuts and JOBS Act, and the fact that very few taxpayers itemize anymore. Most people don't get a benefit for their charitable contributions. The numbers show that in 2018, like 10% of tax returns showed itemized deductions. It used to be more like 30%. So two thirds of the people that used to get a benefit for their charitable gifts don't anymore. So QCDs are a way to get a tax benefit for those gifts. Now, it's not the same this year because you're not offsetting a required minimum distribution. You don't have that to take anymore so you don't get the same exact tax benefit of a QCD that maybe you did in the past. But again, if you're going to give money to charity that you wouldn't otherwise be able to get a deduction for because you're below the standard, then using the QCD can be a way to do that, reduce some of those IRA dollars, avoid a future tax liability when you have to take that money off. QCDs are very valuable still even today under these situations.

Benz: So you mentioned that very few taxpayers are itemizing today. Let's talk about this special above-the-line deduction for charitable contributions. It's not big. But say a retiree wants to do a QCD. Can they also take that above-the-line deduction on $300?

Steffen: Yeah, so one of the things that came out of the CARES Act is a brand-new permanent above-the-line charitable deduction. It's not a big number. It's $300. So even for somebody in the top tax bracket, you're only going to save yourself about $100 of tax. So it's not material from that standpoint, but it is a $300 deduction that you didn't get a couple months ago. And it's a permanent thing, unlike most of the things that these other relief acts that have been temporary. This $300 reduction is permanent. It's only for people who don't itemize. So if you were somebody who took the standard deduction, you weren't getting any benefits for your charitable gifts, now you can get $300 worth of deduction for that.

A couple of quick things, it does have to be cash. You can't give it to a donor-advised fund or certain other types of organizations. And you can do that in addition to your QCD. So the $300 deduction you get would be a separate gift you'd write. It wouldn't come from your IRA, you would do it from your regular taxable account, your checking account, whatever you would do. But you could do that in addition to the qualified charitable distribution. So it's a couple of different ways for people who don't itemize to maybe get a tax benefit for their charitable gifts.

Benz: Okay, Tim. It's always great to get your insights. Thank you so much for being here.

Steffen: Thanks again, Christine.

Benz: Thanks for watching. I'm Christine Benz for morningstar.com.