RMDs Return in 2021: What You Need to Know

The COVID-19 pandemic has instigated upheaval and change around the world. The finance sector was not immune to changes brought on by the pandemic; in addition to causing months of market volatility, the pandemic also led to legislation changes relating to Required Minimum Distributions (RMDs). The SECURE Act that was passed in late 2019 included a provision allowing those in “RMD phase” (individuals 72 and older or individuals who inherited an IRA) to skip the required IRA distributions for 2020.

Remember, that RMDs are the minimum amount required to distribute from your IRA – you can always take more out. However, money distributed from an IRA is subject to federal (and possibly state) income taxes depending on where you live. The SECURE Act benefited seniors by allowing them to keep more money invested in a tax-sheltered account for a longer period of time.

The legislation also provided the opportunity for individuals to convert assets into a Roth IRA. Roth Conversions require that the RMD must be met before the conversion of IRA assets. Without having to take RMDs, seniors were able to convert IRA funds (pre-tax) into a Roth IRA (tax-free) easily since their income were artificially low in 2020.

Since RMD requirements were reinstated for 2021, let’s review the basics:

Calculations, Distributions & Timing

To calculate the amount of your RMD each year, the IRS uses the IRA account value (as of 12/31) for the previous year divided by a life expectancy table value determined by the IRS. Assuming that your account value goes up (numerator) and life expectancy factor goes down (denominator), your RMD will likely continue to increase over time.

Remember that distributions from Traditional IRAs are generated from a pre-tax account, so you should work with your custodian or advisor on determining the proper federal and state tax elections for your specific situation. When you distribute your RMD, custodians can automatically withhold federal and state income taxes for you. This helps avoid shocking tax bills when you file your taxes the following year. Depending on your needs, you can simply transfer the distributed funds to your checking or savings account, or you can distribute the money into a taxable brokerage account to reinvest the proceeds.

Failing to distribute the RMD is a significant mistake that many investors have made. Any remaining RMD dollars not distributed out of an IRA by 12/31 could result in a 50% penalty. For example, if you had a $20,000 RMD that was not distributed before calendar year-end, the IRS would impose a $10,000 penalty. The IRS can grant penalty relief if individuals miss their RMD when self-reporting their taxes and take action to correct the mistake. In this instance, taxpayers would file Form 5329 to request relief.

Individuals have the entire calendar year to distribute the RMD from an IRA. The one exception to the distribution timeframe is for the first RMD: in the year you turn 72, you actually have until the following April to distribute the money. (For example: if you turn 72 in June 2021, you have until April 2022 to distribute the RMD for 2021.) It is important to note that if you decide to wait to take your first RMD until in 2022, you will still be required to make RMDs in 2022. This may create a larger tax burden, so talk with your financial advisor about the first year you expect to receive your first RMD.

Charitable Distributions

Philanthropic investors should consider giving directly to charity from an IRA. A Qualified Charitable Distribution (QCD) allows you to give directly to charity tax-free. In order to count as a QCD, the charity must be a 501(c)(3) organization. If donors give to charities that do not have the appropriate tax status, it could cause A LOT of problems.

To be eligible to make QCDs, you must be at least 70 ½ years old. These contributions cannot exceed more than $100,000 per year.

Many custodians give investors an option to write checks from their IRA. This helps individuals streamline their giving by donating IRA distributions directly to their favorite charities. If donors give to charities that do not have the appropriate tax status, it could cause A LOT of problems.

Note that custodian’s often just report how much money was distributed from an IRA – not whether it was an RMD or QCD. It is always a good idea to keep accurate records and to inform your CPA how much you gave directly to charity to avoid paying taxes on that amount.

Employer-Sponsored Plans

Company retirement plans such as 401(k)s (pre-tax and after-tax) can also be subject to RMDs after plan holders turn 72. There is an exception if you are still employed and you own less than 5% equity of the company. This benefits older workers by allowing their account(s) to grow tax-deferred inside their employer-sponsored plan(s).

Do Roth IRA’s have RMDs?

One of the best ways to avoid RMDs is to consider a Roth IRA. Roth IRAs are funded with after-tax money, grow tax-free, and distributions in retirement years are not taxed. Retirees can avoid large RMDs from IRAs and 401(k)s by converting assets into a Roth IRA over time. Remember, converting pre-tax money into an after-tax (Roth) account does incur income taxes.

Staying up-to-date with current tax law is critical in order to strategize how you manage your money. With the return of RMDs in 2021, we hope this refresher has been helpful. If you have additional questions on this topic, please see our “Contact” tab to connect with one of our advisors at Taylor Hoffman.

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