After a brief hiatus in 2020, required minimum distributions (RMDs) made their re-appearance for 2021.
The Coronavirus, Aid, Relief, and Economic Security (CARES) Act waived RMDS in 2020, meaning that seniors and retirees were not required to take money out of IRAs and workplace retirement plans.
However, what most impacted RMD rules was the establishment of the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act). We will talk about that more below.
Need a bit of a refresher on RMDs and how you can plan ahead for retirement? You’re in luck. We will dive into how RMDs work, where you can avoid tax penalties, how 2020 impacted RMDs, and more.
How Required Minimum Distributions Work: Everything You Need to Succeed
A required minimum distribution (RMD) is the amount of money that must be withdrawn from an employer-sponsored retirement plan or IRA-based plan. You can withdraw contributions when you reach the age of 72, or 70 ½ if you reached 70 ½ before January 2020. RMDs are required unless you have not yet terminated your employment with the employer.
Remember the SECURE Act? Well, it changed the age rules for RMDs a bit. If you reached the age of 70 ½ in 2019, the prior rule applied, and you had to take your first RMD by April 1, 2020. However, if you turned 70 ½ in 2020 or later, you’re required to take your first RMD by April 1st of the year after you turn 72.
Also, don’t think about skipping out on RMDs! If you do, you will be subject to a 50% penalty on the amount you were supposed to withdraw (yikes!).
The RMD rules do not apply to Roth IRAs. But they do apply to all other employer-sponsored retirement plans, including:
- Profit-sharing plans
- 401k plans
- 403b plans
- 475b plans
These rules also apply to IRA-based plans, including:
- Traditional IRAs
- Simplified Employee Pension (SEP)
- Salary Reduction Simplified Employee Pension Plan (SARSEP)
- Savings Incentive Match Plan for Employees (SIMPLE) IRA
If you’re older than 72, you must take RMDs by December 31st of each year. However, if - and only if - you were turning 72 this year and taking your first RMD, you would have until April 2022 to do so. Keep in mind, by waiting, you’d need to take two RMDs in one year: the first in April and the second by December 31.
When To Take RMDs for Inherited IRAs And Important Tax Info
Now you have a better idea of when you have to take RMDs from your retirement account, but what happens if you’ve inherited an IRA?
The beneficiary must still take RMDs, but the dates by when they must take them depends on,
- The date of the original account owner's passing, and
- The state of the beneficiary themselves.
Taxes can also get a little tricky in this situation. If you inherited a Roth IRA, you wouldn’t owe taxes on withdrawals of the earnings but only if the original owner held the account for a minimum of 5 years. If they held the Roth account for less than 5 years, taxes would have to be paid on the earnings in the account (capital gains and dividends). The contributions themselves would be tax free in either case. However, if you inherited a traditional IRA, you will owe taxes on all withdrawals.
The SECURE Act also impacted when beneficiaries can withdraw money from inherited IRAs by eliminating the stretch provision. Most non-spousal beneficiaries are required to withdraw all funds from an inherited IRA within 10 years of the original owner's death. Previously, beneficiaries could “stretch” the distributions throughout their lifetime, providing more flexibility and control from a tax and cash flow perspective.
If you’re under age 59 ½, you won’t be charged any penalties, but you will be required to pay income taxes on the distributions.
Spouses have a bit more flexibility than non-spousal beneficiaries. For surviving spouses, they can:
- Treat the IRA as their own and designate themselves as the account owner
- Rollover the inherited IRA into their personal IRA
- Act as a beneficiary rather than utilizing the IRA as their own
The decision is usually based on when they need to take their RMDs or whether the deceased was taking their RMDs or not upon their passing. It is important to know that each case is different and should be dealt with on an individual basis.
How Does 2020 Impact RMDs, And What Are Next Steps For Retirees?
In 2020 RMDs were suspended, and because of that, the situation got a lot more complicated.
We’ll break it down for you with a hypothetical example. Let’s take two retirees: Amy and Derek. Amy turned 70 ½ on December 31, 2019, and Derek turned 70 ½ on January 1, 2020. For Amy, the rules before the SECURE Act would apply, and she would owe an RMD for both 2019 and 2020. But Derek would fall under the SECURE Act rules, so he would be taking his first RMD by the end of 2021.
As we said earlier, RMDs were waived by the CARES Act in 2020, but that waiver did not extend to 2021. This means that anyone 72 or older, as of December 31, 2021, must withdraw their RMD by the end of the year to avoid penalties (unless this is their first RMD).
In short, retirees that suspended their RMD withdrawal in 2020 must take them by the end of 2021.