RMD Rule Reminder

Keeping up with tax rule changes was never easy. But the flurry of tax changes in response to the COVID-19 pandemic has been absolutely head-spinning. A few of those changes impact the rules for required minimum distributions (RMDs) from retirement accounts. RMD rules are how the IRS prevents taxpayers from avoiding tax payments on retirement funds that were invested pre-tax, or before any taxes were paid on the income used for the retirement investment.

On December 20, 2019, the Setting Every Community Up for Retirement Enhancement Act (aka “Secure Act”) was signed into law. The Secure Act changed IRA distributions and contributions in three big ways:

  • Required Minimum Distribution (RMD) Age Increase

Under prior tax law, RMDs had to begin no later than April 1 following the year in which a person turned age 70½. For taxpayers who were not already age 70½ by December 31, 2019, the age to start taking RMDs is extended to 72. Distributions don’t have to be postponed to 72; it’s just an option. What’s better – waiting or not – depends on individual circumstances.

  • Contribution Age Restrictions Repealed 

Before the Secure Act, workers over age 70½ were not eligible to make contributions to an IRA. That contribution age limit has been eliminated. Yea! Slight damper on that celebration, though – the same rules about who can and cannot deduct a traditional IRA contribution apply, regardless of age. 

  • Inherited IRA “Stretch Distributions” Eliminated for Non-Spouses

Traditional IRAs that are inherited by someone other than the owner’s spouse can no longer be distributed over the life of the beneficiary. Distributions now must be taken within a ten-year period after inheritance. This new rule eliminates the options for non-spouse beneficiaries to use inherited traditional IRAs as part of his or her own retirement planning.

So, what does this mean for 2021 RMDs?

  • Individuals who reached 70½ in 2019 or earlier and were not required to take an RMD for 2020 are required to take an RMD for 2021 by December 31, 2021. 
  • Individuals who did not reach age 70½ in 2019 will reach age 72 in 2021 will have their first RMD due by April 1, 2022, and their second RMD due by December 31, 2022. 
  • To avoid having both amounts included in their income for the same year, the taxpayer can make the first withdrawal by December 31, 2021, instead of waiting until April 1, 2022. After the first year, all RMDs must be made by December 31.

Tax rules are always changing. Keeping up is always challenging. For help to meet the challenge, checkout the IRS website – HTTPS://WWW.IRS.GOV/NEWSROOM/TAX-TIME-GUIDE-IRS-REMINDS-TAXPAYERS-OF-RECENT-CHANGES-TO-RETIREMENT-PLANS.

Tax and Retirement Savings with a SEP IRA

Every taxpayer wants to reduce her or his tax bill. Business owners, especially, are constantly on the hunt for tax deductions. In addition, business owners who want to retire some time in the future are looking for ways to fund that nest egg. My tax clients who own their own businesses ask about tax and retirement savings regularly. That’s at least one thing that COVID-19 hasn’t changed!

Good news for business owners who want tax and retirement savings – they can do both with a SEP IRA! A “Simplified Employee Pension Individual Retirement Arrangement,” or SEP IRA, is the retirement plan of choice for many small business owners. Here are three reasons why:

  • Easy and Flexible

A SEP IRA is easy to set-up with your bank, your investment advisor or a mutual fund. Just set it up and fund the account before filing the year’s tax return, or by the tax return due date, including extensions. Annual contributions amounts are flexible, which is good if business cash flow varies from year-to-year.

  • Generous Contribution Limits

A SEP IRA allows you an annual contribution of up to 25 percent of net business profits, after netting out the deductible half of self-employment taxes. That calculation is a little tricky so you’ll need some help to get it right. There is an annual dollar limit, too. For 2021, it’s up to $58,000. Contributions must be made for eligible employees.

  • No Costs

A SEP IRA has no start-up or operating costs that are often required for a conventional retirement plan. However, any investments selected to fund the account may have a management or investment advisory fee. It’s important to get a clear understanding of any fees or charges that will defray your retirement funds.

Business owners should keep in mind that distributions from a SEP IRA work just like a traditional IRA – any funds taken out before age 59½ are subject to a 10% early withdrawal penalty, on top of the federal and state income tax. 

Saving for today and tomorrow at the same time could be the best news of 2021! Business owners on the hunt for ways to achieve tax and retirement savings at the same time should set up and fund a SEP IRA. Want to know more? As usual, the IRS website has more helpful details, at https://www.irs.gov/retirement-plans/plan-sponsor/simplified-employee-pension-plan-sep.

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.