Retirement Distributions and the CARES Act

Tax rules prevent you from stashing away your pre-tax retirement money indefinitely to avoid paying taxes. Some of the rules about pre-tax retirement accounts have changed multiple times, making it a real challenge to keep up. Age and distribution rule changes for annual Required Minimum Distributions (RMDs) from traditional Individual Retirement Account (IRA) and other pre-tax retirement plan distributions are particularly head-spinning.

An RMD is just what it sounds like – a required distribution that is calculated and paid annually based on the taxpayer’s age and pre-tax retirement plan balances. The RMD amount is included in taxable income. The good news – there are online tables to help to calculate the RMD amount that must be taken every year. The bad news – a 50% penalty is assessed by the IRS if the minimum RMD is not taken by the deadline (e.g., April 1, 2020, for tax year 2019). Quite a strong incentive to follow the RMD rules.

Back in December 2019, the Setting Every Community Up for Retirement Enhancement Act (aka “SECURE Act”) was signed into law. The SECURE Act changed several important aspects of distributions from traditional (pre-tax) IRAs, 401(k) plans, 403(b) plans, and other pre-tax retirement plans. For example, the age when RMDs must start increased from 70½ to 72. See my December 11, 2019, blog post http://www.searlebzllc.com/2019/12/ for details about SECURE Act changes.

Well, because of COVID-19, portions of the December 2019, the law related to RMDs didn’t stand for long. On June 23, 2020, the IRS announced that, per the Coronavirus Aid, Relief, and Economic Security Act, known as the CARES Act, the RMD is waived for 2020. Taxpayers over 72 who had already taken her or his RMD for 2020 from a pre-tax retirement account has until August 31, 2020, to roll the funds back into the account. Ordinarily, RMD rollbacks need to be done within 60 days of the distribution.

The IRS is also giving taxpayers a couple of other breaks by not counting the RMD repayment toward the rule that prohibits more than one rollover per 12-month period and the restriction on rollovers for inherited IRAs. Nice breaks but more to track. 

Some of the rules about pre-tax retirement accounts have changed multiple times, like RMDs from pre-tax retirement plans that changed twice in less than a year! Keeping up can be hard. Sure, you can hire a tax professional to help you out, but you don’t have to. The best place for all the latest tax information is free and always available – www.irs.gov!

Save for Retirement and Get a Tax Credit

Saving on your 2017 income tax bill while saving for retirement could be an even better deal than you thought. In addition to reducing your taxable income by funding an IRA or employer-provided salary-reduction arrangement, eligible taxpayers could also get a Saver’s Tax Credit.

 

A tax credit is a dollar-for-dollar reduction of your tax bill, as opposed to a tax deduction, which reduces your taxable income. A tax deduction reduces your tax bill based on your tax rate – the higher your tax rate, the higher your tax savings.

 

Figuring out whether you could receive a Saver’s Credit depends on the answers to three questions:

 

  1. Who is eligible for the credit?

    To claim the Saver’s Credit for 2017, the taxpayer must be at least 18, cannot be a full-time student, and cannot be claimed as a dependent on another person’s return. Her or his adjusted gross income cannot be more than specified limits, based on filing status (i.e., $62,000 for married filing jointly, $46,500 for head of household, or $31,000 for single, married filing separately, or qualifying widow(er).

  2. What 2017 contributions are eligible for the credit?

    Eligible contributions include funding a 2017 traditional or Roth IRA made by April 17, 2018. Salary reduction plan contributions, such as to an employer’s 401(k), SIMPLE IRA, SARSEP, 403(b), or 457(b) plan, are also eligible. Rollover contributions of any type are not eligible for the Saver’s Credit.

  3. How much is the Saver’s Credit?

    The amount of the Saver’s Credit is based on a percentage of the contributions that were made for 2017. The credit rate is between 10 and 50 percent, depending on income and filing status. For example, a single taxpayer with earned income of $31,000 who makes a $1,000 IRA contribution for 2017 is eligible for a $500 Saver’s Credit.

Want to Save for Retirement Tax-Free?

If you are thinking about skipping a 2016 IRA contribution because it’s not tax deductible – Think Again! Contributing to a non-deductible traditional or Roth IRA means growth that is never taxed. The earlier you begin investing in an IRA the longer you receive the benefit of tax-free growth.

 

Three common questions about IRAs:

 

How Much Can I Contribute?

Your maximum contribution amount for 2016 is $5,500 and an additional $1,000 for ages 50 or above. The contribution amount is based on filing status and modified adjusted gross income. For example, in 2016 a single taxpayer can make the maximum contribution up to a modified adjusted gross income amount of $117,000. Contributions are reduced the higher the income. In addition, don’t forget about checking with your employer to see if you can contribute any more into your employer- sponsored §401(k) plan, §403(b) plan or §457(b) plan before the year ends.

 

Can I Convert a Traditional IRA to a Roth?

If your income decreases and you fall into a lower bracket you could consider “converting” nondeductible traditional IRA funds into a Roth IRA and pay less tax in the year of conversion. You could pay less tax on the growth or perhaps no tax if your income has really dipped in a particular year or years. The conversion can be done in pieces and is not an all or nothing approach.

 

What About Distributions?

When you do start taking distributions on your IRA after age 59½, only some of it will be taxed and some will be a tax-free return of your investment. Distributions taken before age 59½ are subject to a 10% early withdrawal penalty.

 

These plans allow tax deferral and permit tax savings in the current year with the growth deferred into another period when distributions are received. For issues and questions dealing with a Roth IRA, nondeductible IRA and employer sponsored plans, contact me for more details.