By Gary Boatman
This week, we are going to discuss income taxes related to required minimum distributions from retirement accounts.
The CARES Act was passed in March to deal with the economic destruction going on because of the pandemic. One of its provisions made taking required RMDs optional in 2020.
In some ways, this seemed inconsistent with many of the goals of pumping money into the economy to stimulate growth. I believe the reason this was offered was to allow time for stock market recovery.
We had a very unusual, V-shaped crash in which the market went down about 30% one month, then recovered most of that loss the next month. This is not a normal market behavior.
In 2021, people are required to again take RMDs or face a 50% penalty. Anyone who was born in 1949 or earlier will be 72 by Dec. 31, 2021, and must withdraw funds according to the rules. This rule applies only to qualified money such as 401(k)s, and individual retirement accounts.
The amount that must be taken out depends on your age. The SECURE Act which became law on Jan. 1, 2020 changed the age when RMDs start to 72. Before that, they began at age 70½.
People who had inherited stretch IRAs were not required to take RMDs last year, either. Before the SECURE Act, this was a fantastic way to leave unneeded money to children or grandchildren.
While they were required to take distributions from the stretch, it was based on the beneficiary’s age. A 10-year-old might have to withdrawal 1%, while the underlining investment was earning 5%. This was a powerful legacy-building strategy. People who died before Dec. 31, 2019, and left a stretch were grandfathered under the old rule.
Those who inherited an IRA in 2020 are required to take distribution this year also. The new law, however, requires that all of the funds must be taken out of the account before the end of 10 years from the date of death. This makes them pay taxes at the time of withdrawal.
So, if you are leaving money to your adult children, they may be receiving this during their prime earning years. The inherited IRA could put them in a high tax bracket.
The SECURE Act also applies to Roth IRAs. An account still must be liquidated within 10 years. However, it would be beneficial if cash flow allowed it to take all of the funds out on the 364th day of year 10. This way, you could obtain maximum tax-free growth for the beneficiary. You would not do so in most cases for a taxable IRA.
These rules do not apply to spousal beneficiaries. They are the only ones who can make a spouse’s IRA theirs.
A spouse is the only beneficiary who can make someone else’s their own. If they are under age 59½, they usually should not make this change because if you take money out of your IRA before age 59½, you will be accessed a 10% penalty. By keeping it in the name of your husband or wife, you can avoid this penalty. Once you reach this age, you can then change it to your own name.
We will discuss some other tax changes in a future column. Remember, this planning is very important, because it is not just how much you earn that is important, it’s how much you get to keep.
Gary Boatman is a Monessen-based certified financial planner and the author of “Your Financial Compass: Safe passage through the turbulent waters of taxes, income planning and market volatility.”
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