With the ongoing COVID-19 crisis and tax law changes, what unforeseen financial and tax challenges are we headed for? Let us look at the recent CARES Act tax law changes that derived from the current epidemic. One change included no RMD requirement for tax year 2020. Sounds great but let us play devil’s advocate on five potential pitfalls by not taking the RMD in 2020.
1. Increased RMD Requirements in the future tax years.
Not taking the RMD in 2020 will allow additional time for the taxpayer retirement investment to grow which makes investment sense since the market continues to break records in growth. But in this scenario, future RMD requirements will increase due to the continued growth in the taxpayer’s overall retirement investment balance. This increase in future income will lead to the consequences of higher income:
· Increased Adjusted Gross Income
· Increased Taxable Income
· Increased Taxable Social Security
· Higher Medicare Premiums
2. Not paying enough tax
One of the benefits brought on by the Tax Cuts and Jobs Act was the reduction of the tax brackets overall. The bottom 4 tax brackets (10%,12%,22%, and 24%) are cheaper in comparison than the first 3 of the older brackets (10%, 15%, and 25%). It would be wise to properly maximize the bracket you are resting in. If not taking a distribution causes you to drop into a lower tax bracket you may miss the opportunity to have your IRA distribution taxed at 12% or 22% now versus 25% or higher in the future.
3. Underpayment Penalties
In many cases, taxpayers use their IRA distributions to pay the tax on their other income through federal and state withholdings. The decision to not take your RMD will indeed lower your income, however, you now have lost one of the only sources of taxes paid throughout the year. You can still pay estimated taxes at the end of the year, but since underpayment penalties are calculated every quarter, you may not be able to stop penalties from earlier in the year.
4. Legacy Planning
The S.E.C.U.R.E Act took away a very tax-efficient benefit for beneficiaries of your IRA. Prior to the act they were able to elect to take distributions over their lifetime. Under current law, they are forced to take out the entire balance within 10 years. This increases the potential that your heirs will potentially pay a higher tax rate after you pass than you would now. Leaving the money in your taxable IRA rather than moving it to a more favorable account could violate your big picture tax plan.
5. Cash Flow
It may seem like a brilliant tax savings idea to not take the RMD and save some money on your tax bill this year, but if that action means your savings or checking account takes a hit it may not be the best move. Especially considering the current tax brackets. If not taking a distribution in 2020 translates to a higher distribution in 2021 it may not have been the best decision. Consider what your lifestyle requires and do not feel guilty to take what you need at the cheapest rates.
To make the most informed decision we recommend taking advantage of our projection where we consider your income, age, and tax before making any transactions. For further assistance with investment and tax projections regarding the CARES Act and RMD suspension, consult with one of our tax and investment professionals.