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posted by: Radnor Financial Advisors

Coronavirus Aid, Relief, and Economic Security (CARES) Act – IRA Distributions

As we continue to parse through the recently passed CARES Act (Coronavirus Aid, Relief and Economic Security Act), our hope is to separate the full Act into separate sections and review some of the planning elements. As with most financial and tax provisions, there is not a clear right or wrong path forward. Most often, one needs to take a moment and review their full financial picture and find the right path forward to maximize after-tax return and benefit. Often, this path is created by the sum of various actions as compared to a singular action point.

In today’s post, we are reviewing the new provisions around IRA distributions. As we begin, we note that under traditional rules, IRAs are intended to provide income for retirees (those over the age of 59 ½) and constitute taxable income at the time of distribution (required to start at age 72 (previously age 70 ½). While we note that some taxpayers may have basis within their IRA account and also may have ROTH IRA account balances, we are not focusing our discussion on these aspects at this time.

A few key changes within the CARES Act:

  • Required Minimum Distributions (RMDs) are NOT required for 2020 (distributions already taken can be returned). To note, this includes any first year distributions delayed from 2019 into 2020.
  • Distributions of up to $100,000 prior to age 59 ½ are not subject to 10% excise tax
  • Distributions of up to $100,000 can be reported as income and/or returned to an IRA over a three year period
  • NOTE: While the suspension of RMD requirements is in place for all taxpayers, the remaining two provisions are only for taxpayers affected by Coronavirus.

As we review, we also note that some taxpayers traditionally use their IRA RMD as a source for federal and state income tax withholding and may forego the use of estimated quarterly tax payments. Naturally, a decreased or avoided RMD will have an impact on your tax payment planning and may require the use of estimated payments.

Further, recent tax law provisions allowing an IRA Direct to Charity transfer has become an important planning tool. Given higher standard deduction amounts in recent years, the use of the IRA Direct to Charity has gained in popularity as taxpayers may not receive the full tax benefit from charitable transfers claimed as itemized deductions. Again, a change to IRA RMD levels may have an impact on charitable giving planning.

As we review these provisions, we note that the primary purpose of the CARES Act, or so one would think, is to provide flexibility for affected taxpayers to gain access to their retirement accounts in this time of need without undue penalty or cost. However, taxpayers likely have various sources of potential funds to access, of which a Traditional IRA may only be one, and proper planning should be used to create an ordering system as to which lever to pull from first.

It is our belief that maximizing the after tax return or value of the distribution is likely the driving factor in this equation. A few things to note as you consider if foregoing or reducing your otherwise normal IRA RMD level makes the most sense in your planning.

  • Reduced IRA distributions should decrease your 2020 taxable income and associated tax. While generally paying lower tax is attractive, there may be some level of taxable income that is ideal whereby you are able to remain at a lower tax bracket in 2020 than forecasted in future years. Paying tax earlier than required, but at lower tax rates, may be attractive.
  • Reduced IRA distributions in 2020 may leave a higher year-end balance in your IRA thereby increasing future IRA RMDs. An increase to future retirement income levels may push the taxpayer into higher marginal tax brackets.
  • The option to recognize IRA distributions over a three year period may allow for creative planning options to match higher income years with increased deductions. However, be mindful of the addition of future years IRA RMDs and the potential for being pushed into higher income tax brackets.
  • The removal of the RMD has not changed the ability for taxpayers (over age 70 ½) to make IRA Direct to Charity transfers. If you continue to have charitable intent and are otherwise not itemizing deductions, these transfers may remain the most tax effective manner in which to make charitable gifts.
  • For those taxpayers where IRA withholding was used to cover their projected tax liability, we must be careful that the reduction of the IRA income leaves too little paid into estimated taxes. This can be overcome with the addition of quarterly estimated taxes (now delayed for 2020). Proper planning and preparing income tax projections for 2020 through 2022 is a helpful tool in managing and strategizing this process.
  • While the removal of the early withdrawal penalty reduces the cost of using IRA funds, we must be mindful of both the increase to taxable income, and in turn increased total costs, but also the loss of future tax deferred growth. However, the ability to spread this income over three years and, perhaps, more importantly the ability to return the distributed amount in full within three years provides extreme flexibility.

In short, the CARES Act provides many planning challenges and opportunities with regard to your IRA. As with most financial and tax planning discussions, there is no right answer for all taxpayers or situations. We strongly recommend that you meet with a certified financial planner and tax professional to discuss what is the best path forward.

Author: Carl Rosenfeld, CPA, CFP®

Carl M. Rosenfeld

Managing Partner,
Chief Marketing Officer

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