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New Tax Rules for Retirees
Article Highlights:
- IRA Age Limits Repealed
- Required Minimum Distribution Age Increased
- Qualified Charitable Contributions Impacted
- IRA Beneficiary Options Limited
Required Minimum Distribution (RMD) Age Changed from 70½ to 72
In the past, people with traditional IRAs and qualified retirement plans like 401(K)s could begin taking distributions once they reached age 59½ without penalty, but once they reached the age of 70½, they became subject to the RMD rule, which required them to begin taking distributions from the accounts.
On December 19, 2019, Congress changed the law, effective beginning in 2020, by increasing the RMD’s required starting age from 70½ to 72. This change doesn’t help those who turned 70½ in 2019 and were required to begin distributions in 2019 but could delay the first distribution until April 1, 2020, by using the first-year delayed RMD provision. Note that any distribution to these accounts will be taxable unless the original contributions were nondeductible.
Congress Moved to Eliminate the Maximum Age for Traditional IRA Contributions
In previous years, taxpayers’ ability to make contributions to traditional IRA accounts ended when they reached the age of 70½. Effective beginning in 2020, that cutoff has been eliminated, meaning you can continue making contributions if you have employment income. The contribution limit is either $6,000 ($7,000 if you are 50 or older) or your income from working, whichever is less. Although higher-income taxpayers can make contributions, the tax deductibility of the contributions will phase-out when incomes reach certain levels.
However, a traditional IRA may not be the best option, and you should contact this office before making a contribution. In addition, if you are also making qualified charitable distributions (QCDs), the IRA contribution can have a detrimental impact on the QCDs. A QCD is a direct transfer from an IRA to a qualified charity and is discussed further in this material.
Qualified Charitable Distributions
The change will have a direct impact on those who make QCDs. These direct transfers from an IRA to a charity have long allowed retirees to transfer up to $100,000 directly from their IRA to a qualified charity without being subject to taxes.
At first glance, this may not appear to provide a tax benefit. But in addition to counting toward your RMD (if an RMD is required), by excluding the distribution from taxation, you will lower your adjusted gross income (AGI), which will help with other tax breaks (or penalties) that are pegged at AGI levels, such as for medical expenses, passive losses, and taxable Social Security income. In addition, non-itemizers essentially receive the benefit of a charitable contribution to offset the IRA distribution.
However, because the age restriction for making traditional IRA contributions has been repealed, starting in 2020, you can make an IRA contribution and also make a QCD. For that reason, Congress included a provision requiring a taxpayer who qualifies to make a QCD to reduce the non-taxable QCD portion by any traditional IRA contribution that is deducted and made after reaching age 70½, even if the QCD and IRA contribution are not in the same year.
Example #1 – Jack makes a traditional IRA contribution of $7,000 when he is age 71 and another $7,000 contribution at the age of 72. He claims an IRA deduction of $7,000 on his tax return for each year. Later, when he is 74, he makes a QCD of $10,000 to his church’s building fund. Since Jack made the IRA contributions after age 70½, his QCD must be reduced by the post-70½ contributions that were deducted (but not reduced below zero). As a result, the $10,000 is taxable. However, he can claim his $10,000 donation to the church building fund as a charitable contribution on Schedule A if he itemizes his deductions.
Example #2 – Bob makes a traditional IRA contribution of $7,000 when he is age 71 and another $7,000 contribution at the age of 72, and he deducts the IRA contributions on his returns. When he is 74, he makes a QCD of $20,000 to his church’s building fund. Since Bob made the deductible IRA contributions after age 70½, his QCD must be reduced by $14,000 for tax reporting. As a result, of the $20,000 QCD, $14,000 is a taxable distribution, $6,000 is nontaxable, and Bob can claim a $14,000 charitable contribution if he itemizes his deductions.
Changes to Eliminate “Stretch” IRAs
Some members of Congress have, for some time, expressed their displeasure with the so-called “stretch” IRAs, which have permitted some beneficiaries, such as young children or grandchildren, to extend the payout periods to decades for the IRAs they inherited.
When someone inherits an IRA or retirement plan, with the exception of a Roth IRA, the distributions from the retirement plan are generally taxable to the beneficiary. In the past, beneficiaries have often been able to use a lifetime distribution option to stretch the payments over a long period of time. That’s how these IRAs came to be referred to as stretch IRAs.
Under the new law, many beneficiaries of IRAs or defined contribution retirement plans must distribute (and pay taxes on) the funds within a 10-year period after the year of the plan owner’s death. This effectively eliminated the stretch IRA.
A surviving spouse can still treat the decedent’s IRA as his or her own or roll it into his or her own IRA, thus permitting a lifetime distribution period. Other exceptions to the new shortened distribution period apply to:
- Disabled or chronically ill individuals, who also continue to have the lifetime distribution option.
- Individuals who are no more than 10 years younger than the decedent, who can choose a lifetime distribution period.
- A child of the decedent, who is generally not required to take distributions until he or she has reached the age of majority (as determined by state law). Once the child has reached the age of majority, the plan funds must be distributed, in any amounts, within the next 10 years.
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