RMD in 2020
Special Retirement Withdrawal Rules in 2020
By Wayne M. Lenell, CPA, PhD
Congress has attempted to assist American taxpayers in a number of ways to overcome some of the financial hardships resulting from the nasty COVID-19 pandemic. One area in which the government is providing some tax and financial relief is with retirement withdrawals.
Required minimum distributions (RMDs). Tax law requires that owners of retirement accounts (e.g., Individual Retirement Accounts, 401(k), 403(b), and 457(b) plans) begin withdrawing funds from their retirement accounts by a certain age. Prior to 2020, the owner of a retirement account needed to begin withdrawing funds in the year in which the individual turned age 70 ½. Beginning with 2020, owners of retirement funds need not withdraw funds until they attain the age of 72. In both instances, the taxpayer could postpone his or her first withdrawal until April 1st following the year the taxpayer turned age 70 ½ or 72, but the taxpayer must then also withdraw the RMD for the second year as well. Therefore, taxpayers opting to postpone their first RMD until April 1st of the following year would have two RMDs for that year. Further, employees with employer-sponsored retirement plans need not begin withdrawals until they separate from employment regardless of their age.
For 2020 only, the Coronavirus Aid, Relief, and Economic Security (CARES) Act suspended RMDs for all retirement accounts. An individual may withdraw funds from a retirement account, but they are not required to do so for 2020.
Repaying RMDs. What about the situation in which a taxpayer withdrew funds from a retirement account prior to the enactment of the CARES act (March 27, 2020) in fulfillment of the then-in-force RMD rules and would now like to return the funds to the account? Normally, a taxpayer may change her or his mind within 60 days of a withdrawal from a retirement account and return the funds to avoid paying tax on the withdrawal. The CARES act extended the 60 day rule to August 31, 2020. Regardless of when in 2020 a taxpayer withdrew funds from a retirement account, the taxpayer may return the funds to the retirement account by August 31, 2020 and avoid paying tax on the transaction. If, however, the taxpayer had taxes withheld on the initial withdrawal, the taxpayer cannot get an immediate refund of the taxes withheld but, instead, will report the withheld taxes when filing the 2020 personal income tax return in 2021.
Withdrawing retirement funds before reaching retirement age. While Congress made provisions to allow taxpayers to keep their retirement accounts intact by forgoing the RMD rules for 2020, Congress also addressed taxpayers who, because of COVID-19-related reasons, would like to withdraw funds from a retirement account before reaching the specified retirement age. Prior to the CARES act, a taxpayer would be subject to regular income taxes plus a 10% penalty for withdrawing funds from a qualified retirement account prior to obtaining age 59 ½ (or age 55 if separating from employment). For 2020 only, taxpayers who meet one or more of the eligibility requirements may withdraw up to $100,000 from a retirement account without incurring the 10% penalty. There are three other 2020-only benefits for qualified COVID-19 related withdrawals as follows:
1. The 20% Federal income tax withholding requirement for early retirement withdrawals is waived.
2. The owner of the retirement account may elect to include the entire withdrawal in 2020 and pay income taxes on it all in one year. Otherwise, the withdrawals will be included in taxable income ratably over 2020, 2021, and 2022.
3. Withdrawals may be repaid to the retirement account at any time during the three years following the date on which the owner of the retirement account withdrew the funds. The amounts repaid to the retirement account would offset the withdrawals in the same way a tax-free rollover results in a tax-free exchange. If, therefore, an individual repays the withdrawals within three years, it is equivalent to a tax-free and interest-free loan from the retirement account. The IRS has yet to provide guidance on how a taxpayer would recoup any taxes paid on withdrawals that were later repaid.
It is important to note that not everyone qualifies for this one-time opportunity to withdraw funds from a retirement account with the aforementioned benefits. The owner of the retirement account must be affected in one of several ways by COVID-19.
● The taxpayer, spouse or dependent is diagnosed with COVID-19 by a government-approved test, or
● The taxpayer, spouse or dependent suffers adverse financial consequences from COVID-19 by:
- Being quarantined, furloughed, laid off, or a reduction in work hours as a result of COVID-19, or
- Being unable to work due to a lack of childcare as a result of COVID-19, or
- The closing or reducing of hours of a business owned or operated by the taxpayer as a result of COVID-19, or
- Having pay or self-employment income reduced as a result of COVID-19, or
- Having a job offer rescinded, or start date delayed, as a result of COVID-19.
Conclusion. Congress, through enacting the CARES act, has addressed two issues involving retirement accounts. First, those who have reached an age in which they would normally be required to withdraw funds in 2020 may choose not to. In this way, if their retirement account balances were impacted by the COVID-19 related market downturn, their funds will have a year to recover before they must resume withdrawing funds in 2021. Secondly, those who are too young to normally withdraw funds from their retirement accounts without facing a 10% Federal penalty may withdraw up to $100,000 without penalty in 2020 provided they meet one of the COVID-19 related eligibility requirements. They may pay the tax on the withdrawal in 2020 or ratably over three years. If they repay the withdrawals within three years, they pay no tax on the withdrawals.