More Retirees can roll over RMDS this year...But you only have until August 31 to do so.
The Internal Revenue Service will permit more of those who have taken a required minimum distribution this year to roll the money back into a retirement plan and give them more time to do so.
In a recent notice , the IRS said taxpayers who already took an RMD in 2020 from a defined-contribution plan, such as a 401(k) or 403(b), or an individual retirement plan may roll those funds back into a retirement account as long as they do so by Aug. 31.
The $2 trillion coronavirus-relief act permits account owners, including those who inherited IRAs, to skip their required minimum distribution for 2020. The provision includes those who turned 70½ in 2019 and would have had to take an RMD by April 1, 2020; beginning this year, the new RMD age is 72.
But some retirement savers had received an RMD this year before the Cares Act was signed into law. To help them, the IRS in an April notice extended the usual 60-day period for rollovers until July 15, 2020, for RMDs withdrawn between Feb. 1, 2020, and May 15, 2020. That relief did not apply to RMDs taken in January or to non-spouse inherited IRA beneficiaries.
With the latest notice, the RMD rollover relief is extended to include non-spouse inherited IRA owners and those who already took an RMD at any time in 2020. The IRS has also extended the 60-day rollover period for any RMDs already taken this year to Aug. 31, 2020.
For example, if a participant received a distribution in January 2020, part of which was treated as ineligible as a rollover because it was considered an RMD, that participant will have until Aug. 31, 2020, to roll over that part of the distribution into another qualified retirement account. If they do so, it will not be treated as income for tax purposes. Repayments to IRAs will be treated as a rollover for tax purposes, and will not be subject to the one rollover per 12-month period limit, it says.
It does not matter how many RMDs you took this year, you can return them all if you do so by August 31, 2020. Those considering rolling back a distribution to first consider whether it will benefit them if they are in a low tax bracket. It might pay to keep that income if it is going to be taxed at a very low rate, which may be the case for many people. You should consult your financial advisor to help make the determination.
ROTH CONVERSIONS RECONSIDERED
The SECURE Act significantly reduced the benefits of an inherited traditional or Roth IRA, by requiring the non-qualified heir (typically anyone other than the spouse) to take the full amount out of the account within ten years of receipt. Interestingly, that provision makes it somewhat more beneficial for some people to make Roth conversions today.
Chances are you know the difference between a traditional IRA and a Roth; the gist of it is that contributions to a traditional IRA are tax-exempt, but when the money is taken out of a traditional IRA in retirement, it is taxed at the retiree’s current tax rate. In contrast, contributions to a Roth are not tax-exempt, but the money comes out tax-free. If you convert from traditional to Roth, then you have to pay ordinary income taxes on the money that is shifted over at ordinary income rates, as the price for getting tax-free distributions in the future.
In general, you don’t want to convert assets from a traditional IRA to a Roth IRA unless you can pay those taxes with outside funds; otherwise you’re reducing the money that can accrue tax-free until the money is needed. The traditional calculation is that the conversion only makes sense if the person’s tax rate today is lower than the future tax rate—and if you have a crystal ball which tells you what future tax rates will be, we would like to have a conversation about it. But some bets are better than others. The years between when a person leaves work and age 72 (when that person has to take required minimum distributions out of the traditional IRA) can be ideal for a conversion. The tax rate during those years when no employment income is earned can be low, and partial conversions up to certain tax brackets can be very attractive. This reduces the required minimum distributions (RMDs).
So what’s the additional argument for a Roth conversion post-SECURE Act? Some people don’t need their IRA assets to pay for retirement. So they take the lowest amount possible—the RMD—out each year, maintaining a balance, which they will leave to their heirs. The additional benefits accrue to the heirs, particularly if the heirs would inherit the account during their peak earning years.
Under SECURE, if the Roth IRA account is inherited, it still has to be liquidated within ten years of receipt—just like the traditional IRA. But the Roth beneficiaries face a simpler set of choices regarding the payment of taxes. If they inherit a traditional IRA, they have to decide whether to take the money out all at once at the end of 10 years, and risk having a huge tax bill because the distribution puts them in the highest tax bracket, or take the money out gradually and forego years of tax-free compounding. If the new owner of the account is in their prime earning years, then they may already be in a high tax bracket and be pushed higher no matter what they do. A big part of the bequest would be lost to taxes.
The Roth IRA beneficiary, meanwhile, has the luxury of allowing the full 10 years of compounding to proceed without any tax consequences to worry about. He or she is never pushed into a higher bracket during peak earning years. A Roth conversion by the parents is thus a way to transfer more assets to the heirs.
Everybody considering a Roth conversion should talk with a professional to get a full analysis of the potential benefits and drawbacks—understanding, of course, that this analysis requires modeling the unknown future tax code and income levels of potential heirs. Paying taxes now for benefits in the future could be a great strategy under a variety of circumstances which are, alas, still essentially unknowable.
LVM WELCOMES WYATT COUNTERMAN, Portfolio Accountant!
Wyatt has accepted the position of Portfolio Accountant. He was our Monroe-Brown intern
from 2018-19 and graduated from WMU in 2019 with a degree in Finance. Wyatt is currently studying for his CFP® designation at the College for Financial Planning.
LVM WELCOMES SAMUEL OHLAND, Intern!
Congratulations to Samuel Ohland on being chosen for the 2020-21 Monroe-Brown
Financial Planning Internship through Western Michigan University.