November 2021 – Retirement Plan Distributions: An Overview
RETIREMENT PLAN DISTRIBUTIONS: AN OVERVIEW
As part of the CARES Act of 2020, rules around retirement plan distributions were adjusted for 2020. In this newsletter, we share an overview of required minimum distributions (RMDs) and important reminders for 2021.
According to the IRS, individuals are not permitted to retain retirement funds in their accounts indefinitely. Individuals who are age 72 and above are required to take minimum distributions from their retirement accounts each year. Please note: while these rules apply to generally all retirement account types, they do not apply to Roth IRA accounts.
CARES Act Changes
In 2020, the CARES Act enabled taxpayers to skip 2020 RMDs, or roll any distributions already made for 2020 back into a retirement account. This change was for 2020 only, and was an effort to provide taxpayers relief by not forcing them to take RMDs during the pandemic. Please note: this waiver did not apply to defined-benefit plans, but did apply to 401(k) plans, 403(b) plans, and IRAs.
While RMDs were suspended for 2020, they are required again for 2021.
Important Reminder for 2021: Distributions Required Again
RMDs are back in place for 2021, and need to be taken from applicable accounts on or before December 31, 2021.
As such, individuals who have previously taken RMDs will want to ensure they take an RMD for 2021. Taxpayers should ensure they re-instate any auto-distributed RMDs starting with 2021, as these automatic distribution settings may still be paused in their retirement accounts from 2020.
Additionally, with RMDs back in place, if you reached age 72 by July 1, 2021 you will need to take your first RMD for 2021 by April 1, 2022. You will need to take subsequent RMDs by December 31st each year after this initial distribution.
Please note that the penalties for failing to take RMDs are significant. If taxpayers do not take RMDs as required, they will pay 50% tax on the amount that should have been distributed.
Along with taking distributions, we also want to consider the tax effect. In most plans, federal tax is automatically withheld at 10% from RMDs unless the plan owner has specified otherwise.
While federal tax is automatically withheld, state tax is not usually automatically withheld. As such, we recommend considering setting up state withholdings within your retirement accounts if possible. This will ensure you are allocating funds to your state tax throughout the year, and will help ease the year-end state tax burden for retirement income.
Depending on the facts and circumstances, those who are taking RMDs may consider adjusting or increasing federal and state withholding percentages in their retirement accounts. If you would like assistance in determining proactive federal and state tax withholdings for your situation, we are happy to prepare a tax projection for you to help determine your ideal federal and state withholdings for 2021.
Estimated Payments and Safe Position
While we have discussed federal and state withholdings for RMDs, the next question concerns whether federal and state estimated tax payments are sufficient in covering taxes owed on RMDs. While estimated payments are designed to ensure taxpayers are in a safe and penalty-free tax position, taxpayers may want to consider increasing these estimates for any substantial changes in RMDs between 2020 and 2021 to help ease the year-end tax burden on retirement income.
If you skipped RMDs in 2020, your 2020 income was lower than it would have been had you taken RMDs. Since generally 2021 federal and state estimates were calculated using 2020 income, they may not be enough to cover 2021 taxes with the RMDs added back into income. While you will still be in a safe and penalty-free position in paying these estimates, the year-end tax burden may be higher.
To ease the burden of paying a high balance in tax due at the end of the year, we recommend that taxpayers examine their individual situations and personal preferences. If you skipped RMDs in 2020 and are taking RMDs again in 2021, you may consider paying additional amounts in estimated tax for 2021. If you would like assistance in estimating your tax due for 2021 including your RMDs, we are happy to help. Please feel free to reach out to us with your specific situation, and we will be happy to help determine the additional amounts needed in estimated tax for your situation.
Karen joined Soukup, Bush & Associates as an intern for the 2010 tax season and interned until she formally began as an associate in September 2012. She reviews both individual and business tax returns and also reviews compilation engagements.
Karen graduated magna cum laude from Colorado State University in December 2010 with her Bachelor of Science degree in Business Administration, with an emphasis in accounting. She also received her Master of Accountancy Degree, with a specialization in taxation, from CSU in 2012. Karen earned her Certified Public Accounting License in 2012 and became a member of the American Institute of CPAs and the Colorado Society of CPAs during that year as well.
In her spare time, Karen enjoys spending time with her husband and their two daughters, working out, camping, and reading thriller and mystery books.