How the CARES Act Affects Your Social Security

If you took your RMDs earlier in the year, you may be able to return them. Should you?
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By Joe Elsasser, CFP

In March, the Coronavirus Aid, Relief and Economic Security (CARES) Act was signed and granted relief to IRA owners who would otherwise be subject to required minimum distributions (RMDs) by allowing them to forego making those distributions in 2020. However, the legislation failed to address the minimum distributions that came out prior to the passage of the CARES Act, including indirect rollovers. So, on June 24, 2020, the IRS released Notice 2020-51 to offer new guidance about how to fix all required minimum distributions that came out of client accounts before the passage of the CARES Act earlier this year.

Up until the end of August of 2020, you are able to replace any amounts that have come out of an IRA, that would have otherwise been considered a required minimum distribution due in 2020, back into those accounts.

Joe Elsasser

Joe Elsasser

You’ll need to take a step back from your retirement income plan and determine whether or not that IRA income is desirable on your return. Sometimes it will be. For others, it may be a situation where annual distributions are more than you want, so taking at least some portion of the distribution this year will help keep future years’ distributions and resulting tax liabilities down.

In other situations, getting those RMDs off of the return can have a really significant positive impact on your retirement income plan. The minimum distribution may have created a situation where Social Security income is now being taxed, capital gains are being pushed out of a 0% capital gains bracket and into a 15% bracket, or even creating a 3.8% net investment income tax.

Consider the situation of Tim and Tammy Smith who both turned 74 this year. Tim and Tammy have $65,000 of combined Social Security income. They expect around $20,000 of net long-term capital gains this year and have $10,000 of interest from bonds and other savings. They also have combined RMDs of $40,000. A mock tax return completed in most of the tax software available to consumers on the market would say they are in a 12% bracket. Not too bad – right? No real reason to worry about the RMD?

In their case, bringing the withdrawal from their IRA down from $40,000 to $30,000 would save them about $2,700 in taxes, or 27%. For each dollar they reduce their RMD, they save 12%, but this also reduces the portion of capital gains that is being taxed at 15% by one dollar, as that dollar now falls back down into a 0% capital gains bracket.

Perhaps more surprisingly, if they reduce their RMD by another $10,000, they will see another $4,841 in tax savings. That’s a 48% tax rate! Remember, this is happening for someone whose tax prep software tells them they are in a 12% tax bracket. Part of the reason for this massive reduction is the interaction between the IRA money and the capital gains outlined above, but in this case, each dollar reduction in the RMD also drops 85 cents of a Social Security dollar back into tax-free range, which in turn takes another 85 cents of a capital gain dollar out of the 15% and into the 0% capital gains bracket.

These situations represent interactions between different types of income that are particularly common in retirement. For Tim and Tammy, it’s an easy decision to reduce their RMD by $20,000 for this year, and if they had already taken their RMD, they now have a way to fix it, at least until August.

Did You Take a Required Minimum Distribution?

If you took a required minimum distribution early in the year, take a look at what your tax situation will likely be at the end of year. If you’re better off not having taken that distribution, your CPA or financial adviser can help you get those dollars back into the account by the August 31 deadline.

About the author: Joe Elsasser, CFP®

Joe is the founder and president of Covisum, a financial tech company focused on creating software that improves lives through better financial decisions. Covisum helps financial advisors serving mass-affluent clients in or near retirement and powers some of the nation’s largest financial planning institutions.

Read more about retirement:

Advantages of Replacing Your RMD with a Roth IRA Conversion in 2020

Ask Bob: How to Fix an "Overcontribution" to an IRA

Don't Miss the August 31 Deadline to Return 2020 Required Minimum Distributions