COVID-19 is impacting many people in a significant way, especially when it comes to finances. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was enacted to help Americans cope with the unprecedented financial fallout from the COVID-19 outbreak. As such, new provisions were introduced to relax some of the rules and regulations on retirement account withdrawals.
The CARES Act now makes it easier to temporarily withdraw funds from your retirement accounts, including 401(k)s and IRAs. However, as with all of the COVID-19 provisions, you must show you have been impacted by COVID-19 to take advantage of these relief provisions.
These reasons may include:
- Being diagnosed or having a spouse/dependent with COVID-19
- Experiencing a layoff, furlough, reduction in hours or inability to work due to lack of childcare during COVID-19 pandemic.
These are just a few examples, but it is imperative that there is a COVID-19 impact prior to withdrawing from your retirement account.
Another important note – The CARES Act does not require employers to follow the new COVID-19 withdrawal and loan rules, so please check with your plan administrator or sponsor first to avoid unexpected tax and penalties.
How does the CARES Act affect early distribution rules and potential taxes?
Under normal circumstances (pre-CARES Act) individuals under 59-1/2 wishing to withdraw funds from their retirement plans would either need to take a loan from the plan subject to plan limits, or take an early distribution and pay taxes and penalties. With CARES Act provisions, this same individual can now take an early distribution of up to $100,000.00 during the 2020 calendar year without paying the 10% penalty tax. The Act also eliminates the mandatory 20% tax withholding from distributions. However, it is important to note that it does not eliminate the potential for income taxes to be due on any amounts withdrawn.
The CARES Act does give an exceptional level of flexibility to manage the income tax liability associated with the withdrawal:
Option 1: You can elect to spread any tax due over a three year timeframe
Option 2: You can elect to pay it all with your 2020 tax return if your income (and potential tax rates) are much lower this year.
Alternatively, the Act gives you three years to redeposit any funds withdrawn during 2020 as opposed to the normal 60 day period. If you choose to take this longer redeposit time period you may need to file amended tax returns along the way once the redeposited amounts (or any amount you choose to redeposit) have been completed.
An additional impact of the CARES Act with respect to loans taken from your current retirement plan changes the period in which a loan must be repaid or treated as a taxable distribution. Typically any loan taken from your retirement plan would need to be fully repaid within 60 days of job change or job termination. With the CARES Act, you will have up to October 15th, 2021.
The impact of the CARES Act on RMDs for 2020
All RMDs (required minimum distributions) from the retirement plans of individuals have a required amount that must be taken as of age 70-1/2 (or age 72 for those born after July 1, 1949). These distributions are also required of surviving spouses and non-spousal heirs who inherit these tax-deferred accounts regardless of age.
However, the CARES Act suspends all RMDs for the calendar year 2020 with the intent to provide a period of “bounce back” from the market downturn. If you’ve already taken your 2020 RMDs, you have 60 days to return it into your account if you want to take advantage of this provision. However, if you took your RMD more than 60 days ago there is currently no provision that allows the return of the funds to your account and it will be counted as income for 2020.
Should I take money from my retirement account?
Thankfully this bit of advice has changed very little. While the options and impact of the CARES Act allow for substantial flexibility, you should consider the actual financial need of your current situation before exercising any of these new abilities as they are currently still going to have an impact on your personal taxes and financial picture. Consult with your tax advisor and financial planner regarding any actions you are considering so that you may carefully weigh any current options.
As always, Sherwood Tax is here and happy to help you navigate these issues during this unprecedented time. You can reach us at (503) 925-4558 or e-mail us at firstname.lastname@example.org.