MoMo Productions | DigitalVision | Getty Images
It’s a common end-of-year refrain: Don’t forget to take your required minimum distribution.
But, just as with everything else in 2020, rules for RMDs, as they are generally known, are different this year. Seniors don’t have to take them.
The CARES Act passed by Congress in March enabled the change. While that package is known for the stimulus money it provided to millions of Americans, it also gave retirees a reprieve from having to take those mandatory annual withdrawals from their retirement savings, including 401(k) plans and individual retirement accounts.
More from FA Playbook:
The pandemic forced advisors to find new ways to engage with clients
You don’t have to be wealthy to hire a financial advisor
Tips from financial advisors for getting your Medicare coverage right
Traditionally, people have had to start those annual withdrawals once they turned 70½. Now, those who turn 70½ in 2020 and after have until age 72 before they have to take their withdrawals.
In 2020, regardless of your age, you can take that task off your to-do list for this year. Experts say that can give advisors and clients a chance to reassess and perhaps put other strategies to work.
“There’s a lot that can be done right at the end of the year,” said Ed Slott, CPA and founder of Ed Slott & Co. “That’s why I would start the evaluation now.”
Stay the course
Admittedly, the best thing to do may be nothing at all.
“There are obvious benefits to keeping that money invested,” said John Boroff, director of retirement and income solutions at Fidelity Investments.
“If that’s an option for people, it certainly is the way to go,” Boroff said.
When making withdrawals, consider leaving retirement investments alone and instead draw from other sources that won’t be taxed as highly.
That could mean selling securities that are taxed as long-term capital gains, which is generally more favorable than regular income, Boroff said.
“The fact that people don’t have to take RMDs is a great opportunity for them to revisit where and the tax implications of where they’re taking funds from,” Boroff said.
Consider a Roth conversion
FabrikaCr | iStock | Getty Images
One strategy called a Roth conversion lets you move funds from a traditional pre-tax IRA to a post-tax Roth IRA.
You will have to pay levies on that distribution now. But that means you can take the income tax-free later. That can be a huge relief to people who do not want to have to pay a lot to Uncle Sam in their retirement years.
Normally, if you had to take an RMD, you would withdraw the funds and pay the taxes on them. But RMDs can never be converted into a Roth, Slott said.
“Now that there are no RMDs, anything that you can take can be converted,” Slott said. “But that opportunity will expire at the end of this year.”
You’re in control of your tax rate, not the politicians. You do a Roth conversion, you just made your tax rate zero for life.
CPA and founder of Ed Slott & Co.
As with all other transactions, timing is everything with regard to when you do your Roth conversion.
“I would evaluate it now,” Slott said. “But I wouldn’t pull the trigger on a Roth conversion until the first week in December.”
By that time, you will know most of your income for the year and can best project how much you’ll pay in taxes, Slott said. Plus, you can factor in extra money from year-end bonuses. It’s also after most mutual fund companies have disclosed potential capital gains taxes from sales within funds.
Notably, the Tax Cuts and Jobs Act that was passed a few years ago made it so you can no longer undo a Roth conversion. So you want to be sure you won’t have any regrets — and you can afford the tax bill — after you make the switch.
You can do more than one Roth conversion per year, and they can be done at any time. It may have made more sense to do such a transaction earlier this year when the markets sank due to the Covid-19 pandemic, rather than now when markets are reaching new highs, Boroff said.
Yet accumulating more money in Roth investments over time will help put the retiree in control of their tax bill, according to Slott. It can be advantageous to do it now while tax rates are low.
“You’re in control of your tax rate, not the politicians,” Slott said. “You do a Roth conversion, you just made your tax rate zero for life.”
Automate future withdrawals
marekuliasz | iStock | Getty Images
It’s easy to get busy and forget to request those annual withdrawals in time. Plus, with the year-end rush, sometimes financial firms may not be able to guarantee a quick turnaround.
The penalties for missing the Dec. 31 deadline are steep: 50% of the RMD amount.
“It’s something you definitely want to avoid,” Boroff said.
That can be done by setting up automated RMDs, he said. You can set that to happen at any time of the year, in one lump sum or in multiple installments.
“It makes it foolproof,” Boroff said.
— Correction: This story has been updated to reflect that more than one Roth conversion that moves funds from a traditional pretax IRA to a post-tax Roth IRA is permitted per year.