The rules for taking required minimum distributions from IRAs, 401(k)s and other retirement-savings plans have changed significantly in the past few years. The SECURE Act, passed in late 2019, raised the age to start taking the required withdrawals from 70½ to 72. Then the Coronavirus Aid, Relief and Economic Security Act, or CARES Act, waived the RMD requirement for everyone in 2020. But the newest COVID relief bill did not extend the waiver, and RMDs are scheduled to resume in 2021. Now is a good time to start making plans for this year’s RMDs. The following steps can help:
- Calculate your RMDs now.
- Decide when to take the money.
- Choose which accounts to tap.
- Make a plan for taxes.
- Start shifting your investments now.
- Consider giving your RMD to charity.
- Watch out for any more RMD changes during the year.
Calculate Your RMDs Now
Even though you have all year to withdraw the money, you can calculate your 2021 RMD anytime now. The 2020 RMD was eliminated, not just delayed, so the calculation in 2021 isn’t any different than it was in years past: Your required withdrawals are based on the balance in your traditional IRAs, 401(k)s and other retirement-savings plans as of Dec. 31, 2020, and an IRS life-expectancy factor based on your age. (See the Uniform Lifetime Table in Appendix B of IRS Publication 590-B for the figures.)
“The amount you have to take is based on the Dec. 31 balance in your accounts for the prior year, so you’ll know now how much you need to take,” says Rob Williams, vice president of financial planning and retirement income at Charles Schwab. “Your account will rise and fall in value throughout the course of the year, but that won’t change your RMD.”
If you usually have your RMDs paid out automatically but temporarily discontinued the payouts for 2020, contact your IRA administrator to start them back up. Don’t forget to take at least the required withdrawal by Dec. 31 or you’ll face a steep penalty – 50% of the amount you should have withdrawn but didn’t. “Not taking the RMD is one of the stiffest legal penalties that the IRS levies,” says Williams. (If you turn 72 in 2021, you have until April 1, 2022, to take your first withdrawal.)
Some IRA administrators make it easy to manage your RMDs. Charles Schwab, for example, has an online RMD center that calculates the RMDs for your IRAs, lets you start or stop automatic payouts, shows how much you’ve withdrawn so far for the year, and gives you options for paying the taxes.
Decide When to Take the Money
You can take your required withdrawals any time during the year. If you need the money now, you can have your RMDs paid automatically every month or quarter, or you can withdraw the money on your own whenever you need it. You can always withdraw more than the RMD but not less.
Or you may want to wait until the end of the year to withdraw the money. Patrick Carney, a certified financial planner with Rodgers & Associates in Lancaster, Pennsylvania, often recommends that retirees wait to take their RMDs closer to the end of the year if they can afford to do so. “It gives them the whole year of tax deferral on any gains or interest in their IRA,” he says. It also lets them delay paying taxes on the money by withholding it from the payouts. “Unlike estimated payments, where the government cares about the timing and amount of the payments you make, withholding is considered to have been received evenly throughout the year. By waiting until the end of the year, you’re choosing to not give the government an interest-free loan over the course of the year,” he says.
On the other hand, you may want to take the RMD earlier if you want to convert money in your traditional IRA to a Roth IRA or roll over money from a 401(k) to an IRA, which can only be done after you take your RMD, says Jeffrey Levine, chief planning officer for Buckingham Wealth Partners. “The RMD is deemed to be the first money out of your account each year,” he says. “If you want to move money from a retirement plan to an IRA, you need to take your RMD first.”
Choose Which Accounts to Tap
If you have several traditional IRA accounts, you calculate the required withdrawals from each account but then you add up the total RMDs from all of the accounts and can take the money from any one or more of your traditional IRAs. (Roth IRAs do not have required distributions.) You don’t have to take the required amount from each account separately, which means you can choose to take the full RMD from an account with higher fees and keep the money growing in an account with lower fees and better investing options.
For 401(k)s, on the other hand, you must calculate the RMD and take the money separately from each account. You can usually delay taking RMDs from your current employer’s 401(k) if you’re still working at age 72, but you must start to take withdrawals from other 401(k)s and traditional IRAs.
Make a Plan for Taxes
Your RMDs are taxable. If all of your contributions were pretax or tax-deductible, then your entire withdrawals are taxable. If you made any non-deductible contributions, then a portion of each withdrawal will be a tax-free. You have several options for paying the taxes: You can have money withheld from your RMD payments for taxes (10% is the default, but you can have your plan administrator withhold more or less), or you can cover the bill by paying quarterly estimated taxes. Or you can have more money withheld from other income sources, such as a pension or your paychecks if you’re still working.
“Make sure you either withhold enough from each distribution for taxes or have a plan to pay your taxes some other way,” says Carney.
Start Shifting Your Investments Now
If you don’t plan to take the withdrawal until later in the year, now is a good time to start shifting that money to less-risky investments within the IRA, such as a money-market fund or short-term bond fund, says Williams. That way you know the money is there no matter what happens to the stock market – which was a painful lesson for people who needed to take withdrawals when the S&P 500 was down 30% in March.
“We suggest that if you have money you need to spend soon, you should be moving at least that portion of the portfolio into lower volatility, stable investments,” says Williams. “If you get to the end of the year and there’s a drop in the market, you won’t have to sell stocks at a fire sale if you need to spend the money.”
If you don’t plan to spend the money, however, you may be able to take your RMD without having to sell your investments. You could make an “in kind” transfer, which means that you take the money out of the IRA and pay the taxes on it, but keep it invested. “You can transfer the securities or mutual funds to a brokerage account and not sell them, and pay the taxes,” says Williams. “You might just hold them and keep it invested.” Ask your IRA administrator about the steps you need to take to make the in-kind transfer without selling the investments.
Consider Giving Your RMD to Charity
If you’re over 70½, you can give up to $100,000 each year tax-free from your IRA to charity, called a “qualified charitable distribution” or QCD. The gift counts as your required minimum distribution but isn’t included in your adjusted gross income. (Even though the minimum age for RMDs rose to 72, it’s still 70½ for QCDs.)
This can be especially helpful if you don’t itemize your income-tax deductions and wouldn’t be eligible for much of a tax break for your charitable contributions (the newest COVID relief bill does let non-itemizers deduct up to $300 in charitable cash contributions for single filers in 2021, or $600 for married couples filing jointly). Keeping the money out of your AGI can also help you avoid the Medicare high-income surcharge if you’re close to the $87,000 income cutoff for single filers, or $174,000 if you’re married filing jointly, and may reduce the portion of your Social Security benefits that is subject to income taxes.
“Qualified charitable distributions are probably the best tax break available for retirees and are completely underused,” says Carney. He recommends giving the money from your IRA to charity before making other kinds of charitable contributions. Ask your IRA administrator for the procedure – the money must be transferred directly from your IRA to the charity for it to stay out of your AGI.
Watch Out for Any More RMD Changes During the Year
The CARES Act only suspended RMDs for 2020, and the most recent COVID relief bill didn’t extend the RMD suspension into 2021. But keep an eye on future bills in case Congress decides to offer the relief again.
Carney thinks it’s unlikely that RMDs will be suspended this year because the market situation is very different than it was when the CARES Act was passed in late March 2020. “The S&P 500 was down 30% in less than a month. If the markets remained at those levels, RMDs would have forced retirees to take withdrawals at depressed prices, which could have permanently depleted their savings,” he says. “Fast forward nine months since the CARES Act was passed, and today stocks have exceeded their pre-COVID highs to set new records highs, so there’s less of a risk of retirees depleting their savings.”
But that could change, especially if market volatility resumes. “While I don’t see this as a high likelihood, there is some possibility that we see yet another COVID-19 relief bill passed in 2021 which could suspend RMDs similar to how RMDs were suspended in 2020,” says Jamie Hopkins, director of retirement research at the Carson Group and a financial professor at Creighton University Heider College of Business. “If you do not need your RMD in 2021, you can take a more conservative wait-and-see approach here. This just means don’t take out your RMD early in the year, wait to see what Congress does over the first few months of the year. If you are someone who needs to take out the money for spending needs, it really doesn’t matter if Congress suspends RMDs or not.”
If you do withdraw the money and the rules change again, then you may be allowed to put it back in – people who took out their 2020 RMDs before they were suspended in March ended up having until Aug. 31, 2020, to put the money back into the account.