• Recent legislation has relaxed some of the restrictions and taxes on IRA distributions.

• For example, working persons may make contributions to an IRA regardless of age, and required minimum distributions have been suspended for 2020.

• Now may just be the very best time ever to convert a traditional IRA to a Roth.

“The question isn’t at what age I want to retire, it’s at what income.”

–George Foreman, former World Boxing Association Heavyweight Champion

As I’m sure you already know, an individual retirement account (IRA) is a tax-deferred (and in some cases tax-free) retirement account that allows individuals to save for retirement.  IRAs arose out of the Employee Retirement Income Security Act (ERISA) of 1974, in an effort to provide working-class Americans with the opportunity to supplement the social security benefits received in retirement. 

Initially, there was a single type of IRA, and only individuals who were not eligible to participate in an employer-sponsored retirement plan were allowed to open one.  Today, there are at least 7 different types of IRAs (depending on how you classified them)[1], and just about everyone who is working, or has participated in a retirement plan when they were working, can set one up.

The basic characteristics: contributions to the IRA can be made on either a pre-tax (traditional IRA) or after-tax (Roth IRA) basis; income earned on the IRA’s assets is not taxed, and distributions from the IRA are either taxable (traditional IRA) or tax-free (Roth IRA).

Since their inception, IRAs have been subject to a large number of rather stringent requirements intended to limit their tax benefits.  These restrictions include:

• Age Limits. Prior to the Secure Act (discussed below), only persons 70 ½ years of age or younger were allowed to contribute to an IRA, and only if he or she has earned income to contribute.

• Tax Deduction Limits. The tax deduction for IRA contributions phases out as income rises if you participate in an employer-sponsored retirement plan (in which case there is no phase-out).

• Contribution Limits. For 2020, annual IRA contributions are limited to $6,000 ($7,000 if you’re age 50 or older), or your earned income, whichever is less.

• Deferral Limits. “Required minimum distributions” (“RMDs”) must be made to the owners of traditional IRAs when they reach their “required beginning date”.[2]  The amount of each year’s RMD is calculated dividing the prior December 31st account balance by a life expectancy factor that IRS publishes.  RMDs, therefore, increase as the owner ages.

• Withdrawal Limits. Subject to limited exceptions, withdrawals before age 59 ½ trigger a 10% penalty in addition to whatever income taxes may be due.[3]  Loans from your IRA can be used to avoid the penalty, but the loan maximum is $50,000 or 50% of the account balance.

The good news is that recent legislation has loosened some of the above rules, and thereby made IRAs an even more attractive retirement savings vehicle. 

The first such legislation is the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act), which I discussed here.  It repeals the age restriction on contributions to traditional IRAs.[4]  It also raised the required beginning date for minimum distributions to begin to age 72.[5]

The second was the Coronavirus Aid, Relief, and Economic Security Act of 2020 (CARES Act).  While much of this law is intended to buttress the economy, the act also made several changes that are intended to help IRA owners who are experiencing financial hardship as a result of the pandemic.

The CARES Act suspends RMDs in 2020 for all IRA owners. This suspension eliminates the need to make RMDs based on higher December 31, 2019 market values.  If you have already taken your RMD for 2020 within the last 60 days, it may be possible to roll the distribution back into your IRA Then again, if you own a traditional IRA and the pandemic pushes you into a lower tax bracket in 2020, it might make more sense to accelerate withdrawals and thereby take advantage of the lower rates.

In addition, the IRS has extended the deadline to make a 2019 IRA contribution to the earlier of July 15, 2020 and the date you file your 2019 income tax returns.[6]

The CARE Act also has additional hardship provisions for “qualified individuals who:

• Are diagnosed with COVID-19;

• Have a family member who has been so diagnosed; or

• Who, as a result of the outbreak, was (i) quarantined (ii) laid off (or worked less hours), (iii) unable to work due to lack of child care; or (iv) whose business was closed (or open fewer hours).

The following provisions of the CARES Act apply to IRA accounts of qualified persons.

• Qualified persons under age 59 ½ can withdraw up to $100,000 in 2020 without triggering the 10% penalty mentioned above.

• The limits a qualified person may borrow from his or her IRA are doubled to the lower of $100,000 or 100% of the account balance (whichever is less).

• Qualified persons can avoid taxation on IRA distributions by repaying the distribution within 3 years.

• Qualified persons can elect to spread the inclusion of income from distributions over 3 years tax return.

Lastly, and perhaps most significantly in my opinion, the recent bear market brought on by the Coronavirus pandemic has made it an ideal time for many to convert a traditional IRA into a Roth IRA (and thereby eliminate the duty to pay taxes on IRA distributions, and the requirement to make minimum distributions).  That’s because if the value of the investments in your IRA have diminished, the taxes that have to be paid on the conversion will likewise be less.[7] 

Moreover, history teaches that bull markets usually follow bear markets.  In the present case, the stock market could very well recover quickly when the pandemic’s end is in sight.  Converting to a Roth IRA before the rally will mean that the value that was temporarily lost during the crisis, and that will be recovered when the stock market bounces back, will never be taxed. 

[1] Traditional IRA, Roth IRA, Spousal IRA, SIMPLE IRA, SEP IRA, Self-Directed IRA, and Inherited IRA.

[2] Distributions from Roth IRAs are not required and are not required while working provided the IRA owner doesn’t own over 5% of the employer.

[3] Withdrawals to pay college or graduate school tuition and up to $10,000 for a down payment by a first-time homebuyer do not trigger early withdrawal penalties.

[4] Before the Secure Act, you could not make contributions to a traditional IRA once you turned 70 1/2 or thereafter.

[5] This change only applies if you reach 70 1/2 after 2019.

[6] https://www.irs.gov/newsroom/filing-and-payment-deadlines-questions-and-answers (Q17)

[7] It is also important to keep in mind that partial Roth conversions are permitted.  Converting to a Roth IRA gradually can avoid being pushed into higher tax brackets by the conversion.