Friday, April 3, 2020

Changes to Retirement Accounts in the CARES Act

Pathways Advisory Group, Inc.
Evon Mendrin, CFP®

Our recent blog post reviewed some of the aid provisions for individuals and families from the recently passed CARES Act. Today, in Part 2, we’re focusing on the law’s effect on retirement accounts. Let’s dig in!

Coronavirus-Related Distributions from Retirement Accounts

Congress created a specific category of withdrawals from retirement accounts for those that are impacted by the coronavirus - Coronavirus-Related Distributions. These are withdrawals from IRAs and/or employer-sponsored retirement accounts in 2020 totaling no more than $100,000.

You’ve been affected by the virus if any of the following apply:

     Diagnosed with the coronavirus
     Have a spouse or dependent that’s been diagnosed
     Experiencing adverse financial consequences as a result of being quarantined, furloughed, laid off, or having work hours reduced
     Unable to work due to lack of childcare because of the virus
     Closing or reducing hours of a business you own or operate
     Experiencing “other factors” the Treasury/IRS determines are okay

This list is quite broad, and it seems the intent is to allow broad access to those in need during the pandemic. Coronavirus-Related Distributions get the following perks:

     Exempt from the usual 10% penalty - this waives the penalty typically applied when you withdraw from a retirement account before age 59 ½. 

     No Mandatory withholding requirements - certain distributions and rollovers from employer-sponsored retirement accounts (such as 401k’s) generally have mandatory 20% federal tax withholding. Coronavirus-Related withdrawals are exempt from this.

     You can repay the distributions within 3 years - You have up to 3 years from the date of withdrawal to redeposit the amount into an eligible retirement account. This can be the original or another eligible account. If done, you can amend prior returns to claim a refund of tax paid for the amount redeposited.

     The taxable income for the amount withdrawn is spread over 3 years. You can also elect to take it all in 2020. If 2020 income is indeed much lower than usual, you’ll want to be sure it makes sense to spread it out from a tax standpoint.

Waiving Required Minimum Distributions in 2020

Generally, when owners of pre-tax retirement accounts reach age 72 (recently extended from 70 ½ by the SECURE Act), they are required to take a certain distribution amount each year. This is a Required Minimum Distribution (RMD). Distributions are also required when non-spouse beneficiaries inherit retirement accounts.

However, Congress is waiving all RMDs in calendar year 2020! This includes traditional IRAs, SIMPLE and SEP IRAs, 403b, 401k, and government 457 plans. The waiver applies to the account owners themselves, as well as beneficiaries taking annual required distributions.

If you turned 70 ½ in 2019 (still under the old law), but waited to take your RMD until early 2020 (before April 1), you also benefit. That distribution is no longer required, saving you two required withdrawals in 2020!

This is a big help for retirees who don’t need to take RMDs for living expenses - whether due to pension income or other taxable investments. The ability to avoid selling when stocks have declined - or even to rebalance - is a great long-term benefit. This also helps to keep the extra taxable income off of the 2020 tax return.

What if you already took the RMD for 2020 - even a part of it? Well, there’s no direct provision to return those funds to the account.

One potential way to return the funds - and avoid the extra taxable income - is to complete a 60-day rollover. If the distribution occurred within the last 60 calendar days, you can deposit the same amount withdrawn back into an eligible retirement account by the 60th day.

This can only be done if you have not already completed a similar 60-day rollover within the last 12 months. If taxes were withheld on the original withdrawals, the full amount needs to be re-deposited to avoid the taxable income. These can be tricky. It makes sense to chat with your financial/tax advisors on the process.

A second approach - if past 60-days - is if you can show you’ve been impacted by the coronavirus (as written above). If so, you can treat the withdrawals as Coronavirus-Related Distributions.

In that case, you can redeposit the withdrawn amounts over the next three years (from the date of withdrawal). Or, if you choose to keep the withdrawn amounts, you can spread the taxable income over the next three years.

What about beneficiaries? Can they redeposit the funds? Unfortunately, it doesn’t appear so. Beneficiaries can’t complete 60-day rollovers. There doesn’t seem to be a way to get them back into the account. (Different rules for spousal beneficiaries.)

Not perfect solutions, but you may be able to take some action. It makes sense to reevaluate your RMD plan for the rest of the year - including any potential Qualified Charitable Distributions - if the retirement funds aren’t needed for expenses.

2020 Skipped for 5-Year Rule RMDs

A non-designated beneficiary is a non-living, non-breathing beneficiary. Think estates, charities, certain Trusts. When a non-designated beneficiary inherits a retirement account from someone before they reach the age to begin RMDs, there’s a 5-year rule for distribution. The entire account must be withdrawn by the end of the fifth year after death.

However, the CARES Act allows those beneficiaries to skip 2020 when counting the 5 years. It can just be ignored, giving those beneficiaries a 6th year. Of course, this only works for an account owner that passed before 2020. If the date of death was 2020, the 5-years don’t begin until next year!

Loans from Employer-Sponsored Retirement Plans

Many 401k and other employer-sponsored retirement plans allow participants to take loans of a portion of their account values. If you’ve been impacted by the coronavirus (same definitions as above), the CARES Act adjusted the rules for these loans.

For those affected, the maximum loan amount increased to $100,000 (from $50,000).

100% of your vested account balance can be used (up to the $100,000 limit). Typically, when your account is more than $20,000, you can only take a loan of up to 50% of the vested balance.

Lastly, the law allows you to delay payments that would be owed from the date of the law through the end of 2020 for up to one year.

Hopefully, a source of last resort, this allows cash-strapped Americans one more source of funds.

These provisions should allow some relief to those extremely cash-strapped in light of the coronavirus. It also helps those who are able to avoid selling during a market decline and avoid the extra taxable income. Stay tuned for our next article on how the CARES Act helps small businesses!

As always, chat with your tax professional to determine how these provisions affect your tax situation.

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