January 7, 2021
Required minimum distributions (RMDs) from retirement accounts were suspended in 2020, as part of the federal government’s effort to keep the economy afloat despite medical and financial turmoil. Now they’re back, so most people who are 72 or older in 2021 will have to take at least as much as IRS tables dictate from their retirement accounts this year, and pay the resulting tax. Many IRA owners delay RMDs until yearend, but there are good reasons to act sooner rather than later.
Watch the video and read below to learn more:
Thinking Charitably in January Before Taking RMDs
If you are 70-1/2 or older, you should consider making your charitable contributions via qualified charitable distributions (QCDs) from your IRA. For people who are 72 or older, QCDs are especially attractive as they’ll offset RMDs, up to $100,000 per individual per year. If you decide to execute QCDs this year, January probably is the time to begin.
To see the possible tax trap, suppose that Debra Dawson, age 77, had just over $500,000 in her IRA on December 31, 2020. Her RMD for 2021 would be around $24,000, so Debra takes $2,000 a month to satisfy this obligation and avoid a 50% penalty on any shortfall.
Fast forward to late November 2021, when Debra begins to think seriously about charitable donations. Debra and her husband Doug typically give a total of $20,000 to charities such as Torrance Memorial Medical Center. As November turns to December, Debra moves $20,000 directly from her IRA to those charities, using QCDs.
The problem, in this scenario, is that Debra already has taken $22,000 from her IRA: $2,000 per month from January through November 2021. Because Debra is in the RMD stage of her life, the first dollars coming out of her IRA each year count towards her RMD. Therefore, even if she sends $20,000 from her IRA to charity in early December, as QCDs, only $2,000 will offset her $24,000 RMD for the year. Debra will have to report $22,000 of taxable income, from the monthly IRA distributions, through November.
Therefore, a better strategy for Debra would be to send the $20,000 of QCDs to charity in January. (If she was on an automatic monthly RMD payout, Debra should have notified her IRA custodian to suspend those payouts as soon as possible.) Then Debra’s $20,000 of QCDs would have reduced her RMD obligation for 2021, leaving her with only $4,000 to withdraw before yearend and report as taxable income.
As you can see, making the QCDs early in 2021 will enable Debra to reduce her taxable RMDs by $18,000, in this example: reporting $4,000 of taxable income, rather than $22,000. Depending on the Dawsons’ overall income, not only will such a reduction in taxable income result in a lower tax bill, it also may have ripple benefits, possibly reducing the income tax on their Social Security benefits or holding down the premiums they’ll owe in the future for Medicare Parts B and D.
Note that Debra in this example has an IRA slightly larger than $500,000 and a family plan to donate $20,000 a year to charity. Taxpayers who have larger IRAs and intend to make larger charitable contributions stand to benefit even more by using QCDs in January for their annual philanthropy.
Gifting Gains For QCDs In January
Continuing the above example, suppose Debra puts her automatic RMDs for 2021 on hold in early January and sends $20,000 to charities via QCDs. How should she schedule the $4,000 balance of RMDs due this year?
Assuming Debra’s IRA enjoyed stock market gains in 2020—the broad market was up around 20%--she might fulfill the obligation by withdrawing the remaining $4,000 right away. If she directs all the $24,000 of distributions (QCDs plus cash withdrawals) to come out of the equities in her IRA, she would effectively be using the stock market gains for her donations and the RMD balance. Those gains might not be available later, if the stock market suffers a correction during 2021.
Moreover, all seniors with IRAs over $500,000 should consider taking RMDs early this year, if they have stock market gains from 2020. Their RMD obligation can be met from gains that didn't exist just a year ago.
If your IRA grew by 10% in 2020, for example, and your RMD for 2021 is 3.9% of the yearend 2020 balance, the 2020 gain can cover your 2021 RMD. If you wait, you might not have that gain to tap, later in the year. Just make sure you implement any desired QCDs (possibly from those gains) prior to any taxable RMDs.
For everyone subject to RMDs, please contact our office in January. We can help you determine if QCDs are right for you, in your situation. In addition, we’ll develop an overall RMD plan for 2021, so you can contact your IRA provider and make sure you are on a desirable schedule for tapping your account during the coming year.
By Christian Cordoba
CERTIFIED FINANCIAL PLANNER™
Founder, California Retirement Advisors
This content is developed from sources believed to be providing accurate information, and provided by California Retirement Advisors. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. California Retirement Advisors, nor any of its members, are tax accountants or legal attorneys and do not provide tax or legal advice. For tax or legal advice, you should consult your tax or legal professional. #