Congress Just Gave Some Retirees a Tax Holiday
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Congress Just Gave Some Retirees a Tax Holiday

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Congress Just Gave Some Retirees a Tax Holiday

The coronavirus pandemic has left everyone with a lot to worry about, and retirees are in an especially tough position. With stocks having swooned over the past month, those who rely on their investment portfolios to provide financial security and a supplement to their Social Security benefits have suddenly found themselves worried about their financial futures.

Potentially adding insult to injury, many of those who have retirement plan accounts faced the requirement to take distributions out of those accounts -- and pay the resulting tax. Thanks to recent action from Congress and the White House, however, it now looks as though the required minimum distribution rule will get suspended for 2020. That should give some retirees some comfort.

Image source: Getty Images.

The basics of required minimum distributions

The laws governing retirement accounts say that most of those retirees who hold traditional IRAs, 401(k)s, and similar accounts have to start withdrawing at least a minimal amount from them each year. New RMD rules in effect for 2020 require anyone turning 72 in a given year to take a calculated requirement minimum distribution by April 1 of the following year. Those who've already had at least one year's worth of RMDs have to take subsequent distributions by Dec. 31 each subsequent year. Previous rules required anyone 70 1/2 or older to take RMDs, and those rules remain in effect for those who turned 70 1/2 in 2019 or earlier.

In addition, those who inherit IRAs and other retirement accounts also have to take RMDs. The only exception is a surviving spouse, who can take the inherited IRA and roll it into a new retirement account in the spouse's name.

The amount of the required minimum distribution depends on your age and the value of the retirement account as of the end of the previous year. The IRS takes your age and comes up with a certain percentage of your account that you're required to withdraw, with the idea being to have you withdraw the entire account over the course of your expected lifetime.

Why RMDs are tough in bear markets

The problem with RMDs right now is that the coronavirus-driven stock market crash has pushed account balances sharply downward. However, 2020 RMDs would be calculated based on end-of-year 2019 balances, which for most retirement investors were much higher than their current balances are after the decline.

As a result, investors would face two problems. First, they'd have to sell investments in their retirement accounts to come up with the RMD amount at a time when those investments were at rock-bottom prices, essentially locking in their losses. Even worse, they'd still have to pay taxes on the withdrawn amounts, since RMDs are required to get added to your taxable income.

Moreover, the penalties for trying to avoid taking required minimum distributions were harsh. The IRS would charge you 50% of the amount that you were supposed to take for your RMD. That made trying to skip your RMD for a given year a really bad idea.

Some small relief

RMD relief won't do every retiree much good. For many, tapping retirement accounts to supplement other income isn't really an optional thing, and so whether the RMD rules actually require you to take money out of your IRAs and 401(k)s is a moot point.

Nevertheless, for those who've accumulated sizable nest eggs to help them with their retirement finances, suspension of RMDs for 2020 will provide some extra flexibility in their tax planning. Those who still want to take withdrawals will be able to, but those who can afford to put it off will get a nice tax holiday.

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