As if you weren't already worried about running out of money in retirement, recent stock market volatility may have wiped away 20% of your life savings. But don't start making plans to move in with your kids just yet. There's a provision in the coronavirus stimulus bill that may help you stay solvent, despite the recent downturn.
On March 23, Rep. Jennifer Wexton (D-Va.) introduced legislation that would allow retirement savers to skip their 2020 required minimum distributions (RMDs) without penalty. Subsequently, Wexton argued successfully to include that legislation in the $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act that was passed on March 27. Along with the break on 2020 RMDs, CARES also provides for the payout of coronavirus relief payments to American households and a temporary upgrade to unemployment benefits.
RMDs are unpopular among many retirement savers. They are minimum, taxable withdrawals you must take from 401(k)s, IRAs, profit-sharing plans, 403(b)s, and 457(b)s when you reach the age of 72.
Even if you don't need the money to pay your bills, you have to take the distributions and pay the associated taxes. The way the IRS sees it, you've been deferring your taxes in those accounts for long enough -- it's time to start paying the bill. And Uncle Sam means business on this point: Normally, if you take less than your required distribution, you pay a 50% penalty on the shortfall.
Taking RMDs in 2020 may deplete your savings too quickly
RMDs aren't designed to drain your retirement stores, but they have the potential to in 2020. This has to do with how they're calculated, along with the timing of the recent market volatility. In any given year, your RMD is based on your account balance at the end of the prior year and your age. The goal is to mandate a fair distribution amount based on how long your money needs to last.
The thing is, the stock market has flailed this year. Your account balance today is probably much lower than it was at the end of 2019. So, the usual RMD formula would lead to fairly high distributions given what your retirement portfolio is worth right now.
For example, say your 401(k) was worth $750,000 at year end, and you are 74 years old. Since year end, your account value has dropped 18% to $615,000. According to the SEC's RMD calculator, you'd normally have to take $31,512.61 in distributions from that account in 2020. If we recalculate the RMD based on the current account value of $615,000, that equates to lower RMDs of $25,840.34.
Lower distributions are better for your long-term solvency. That's why it benefits you to take advantage of the CARES Act provision and skip -- or at least reduce -- your 2020 retirement distributions. Other advantages include:
- By keeping your money invested, you are better positioned to benefit from a market recovery.
- You retain your income from dividend payers and debt securities.
- Your tax bill will be lower, assuming you don't make up for the lower distributions with another form of taxable income.
Look to other sources of income
Reducing distributions from your taxable retirement accounts is only an option, of course, when you don't need the full amount of those distributions to pay your bills. You may have to look to other sources of income to pick up the slack, such as:
- Roth IRA distributions. RMDs do not apply to your Roth IRAs. You will still have to liquidate some investments and realize losses to withdraw from your Roth, but those Roth distributions aren't taxable.
- Cash savings. Cash savings is an easy source to tap, but take care not to drain your emergency fund.
- Accumulated cash value in a life insurance policy. You could borrow against your life insurance's cash value; usually these loans are competitively priced and have no repayment schedule. The loan does reduce your death benefit until it's repaid. And you will have to keep up with your premiums. Normally cash value loans are tax-free, but they could become taxable if the policy lapses.
- Consulting work. Depending on your work history, you could pick up a temporary consulting job to make ends meet. This is an option if you have deep industry expertise or you have a history of managing corporate teams through change.
If you can swing it, skipping RMDs this year could allow you to bounce back from this downturn. At the least, you'll preserve your income-earning potential and be better positioned to benefit when the market does start to bounce back.