2020 was an eventful year for required minimum distributions, commonly referred to as RMDs. There were two pieces of legislation that were effective in 2020 that produced three noteworthy changes affecting RMDs.
RMD Background
Before discussing the changes, some RMD background is in order. IRAs were enacted as part of the Employee Retirement Income Security Act (ERISA) in 1974. ERISA required IRA and retirement plan account owners to take taxable lifetime annual distributions from their accounts beginning at age 70-1/2 to offset tax savings received from making deductible contributions.
The annual RMD for plan participants and IRA owners is calculated by dividing the value of each account on December 31st of the previous year by a life expectancy factor for the current year from IRS’ Uniform Lifetime Table. All RMD’s must be distributed by December 31st each year. There is an exception for the initial withdrawal which must be taken by April 1st of the year following the year in which you turn 72, which was previously age 70-1/2.
Failure to take RMDs by the specified due date results in a 50% penalty on the shortfall. The penalty can be waived by IRS for good cause if appropriate steps are taken to correct the error in a timely manner.
RMD Beginning Age Increased to 72
The required beginning age was April 1st of the year following the year in which you turned 70-1/2 until 2020. The first legislative change, the SECURE Act, increased the RMD age from 70-1/2 to 72 for anyone reaching age 70-1/2 after December 31, 2019 for 2020 RMDs.
July 1, 1949 is the key date for determining whether you were required to take your initial RMD by April 1st of the year following the year that you turned age 70-1/2 or 72. Here are the rules:
- Anyone born before July 1, 1949 was subject to the age 70-1/2 RMD rule.
- Anyone born July 1, 1949 or later qualifies for the age 72 RMD rule.
10-Year Payout Rule
In addition to increasing the RMD age from 70-1/2 to 72, the SECURE Act eliminated the RMD regime for many retirement and IRA account beneficiaries who inherit accounts for deaths after December 31, 2019. These individuals are subject to a 10-year payout rule effective January 1, 2020.
There are five classes of “eligible designated beneficiaries,” or “EDBs,” who continue to be subject to the RMD rules instead of the 10-year payout rule. These include:
- Surviving spouses
- Minor children up to the age of majority, excluding grandchildren
- Disabled individuals who qualify under strict IRS rules
- Chronically ill individuals
- Individuals not more than ten years younger than the IRA owner
All other individuals, or “non-eligible designated beneficiaries,” or “NEDBs,” are subject to a 10-year rule whereby they must empty their accounts by the end of the tenth year after death. Examples of NEDBs include children after reaching the age of majority and grandchildren. Failure to empty accounts by the end of the tenth year following death results in a 50% penalty on any remaining balances.
RMDs Waived in 2020
The second legislative change that affected RMDs in 2020, although temporary, attracted the most attention. The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, which was signed into law on March 27, 2020 waived RMDs in 2020. I speculated about this possibility in my March 16, 2020 blog post.
The waiver included the following three types of RMDs:
- 2019 RMDs due by April 1, 2020 for anyone born before July 1, 1949 who delayed their initial RMD
- 2020 RMDs from company plans and IRAs
- 2020 RMDs for company plan, IRA, and Roth IRA beneficiaries not subject to the 10-year payout rule
IRS allowed individuals who took RMDs in the beginning of the year to return them to their retirement and IRA accounts up until August 31, 2020. This presented an opportunity to roll over, or convert, distributions to a Roth IRA rather than return them to their originating accounts.
RMD Vacation is Over
2020 was an unprecedented and confusing year for most people, including company retirement plan and IRA account owners and beneficiaries impacted by the RMD rule changes. The beginning age was increased from 70-1/2 to 72, the RMD regime was replaced by a new 10-year payout rule for many beneficiaries, and RMDs were waived. If this was not a wake-up call for the need for holistic retirement income planning, I don’t know what is.
Anyone who is a retirement plan or IRA account owner or eligible designated beneficiary needs to add distribution of RMDs to their 2021 to-do list if they have not done so already. If you did not take distributions from your retirement plan and IRA accounts in 2020, you may be surprised that the amount of your 2021 RMDs is greater than in 2019, requiring you to pay more income tax in 2021 than you did in 2019.
Given the fact that 2021 RMDs are calculated using December 31, 2020 account values, larger 2021 RMDs are a distinct possibility assuming you did not take distributions in 2020. Furthermore, this is more likely if you have an equity-based portfolio that benefited from favorable 2019 and 2020 stock market performance if you did not liquidate your equity holdings during the Covid-19 selloff.
You also need to start planning for how and when you will take distributions if you are subject to the 10-year payout rule since you don’t have the luxury of taking pre-determined RMDs using a generous IRS life expectancy table. Distribution timing is key, especially since income tax rates may increase before the scheduled 2025 sunsetting of many provisions of current tax law. It is critical that you work with your financial advisors to optimize the timing and amounts of your after-tax distributions and avoid a potential 50% penalty if you don’t empty your accounts within ten years.
Welcome to 2021! Your RMD vacation is over.
