The CARES Act Provides Some Retirement Plan Flexibility

If you’re like many Americans, you plan carefully to save enough money for a comfortable retirement. But events outside of your control can affect your retirement plans.

The COVID-19 crisis is such an event. For example, if you’re experiencing economic hardship due to the pandemic you might need to withdraw funds from your retirement accounts this year and could face penalties for doing that, in addition to hurting your retirement nest egg. But the Coronavirus Aid, Relief and Economic Security (CARES) Act might provide some relief. Signed into law in March, the CARES Act is intended to mitigate the economic damage caused by COVID-19.

Tax relief on certain distributions

If you’ve been adversely affected by COVID-19, the CARES Act may allow you to withdraw up to $100,000 from your retirement plans in 2020 in a tax-advantaged way. First, if your withdrawal qualifies, you can spread out any tax liability over three years without interest or a late-payment penalty.

Alternatively, you can recontribute the funds back into your plans within three years of making the withdrawals and not owe any tax on the withdrawals. That’s true even if the action pushes your total contribution for the year above the annual limit. The recontributions can be made in a lump sum or a series of payments.

Qualified withdrawals also are exempt from the 10% penalty that applies to most early retirement account withdrawals (generally withdrawals before age 59½).

For a withdrawal to qualify for all these tax benefits, at least one of these conditions must apply:

  • You, your spouse or a dependent must have tested positive for COVID-19.
  • You’re experiencing adverse financial consequences due to your inability to work during the pandemic.
  • Your pay or self-employment income has been reduced due to COVID-19.
  • You’re unable to work due to COVID-19-related child care issues.
  • You own a business that’s been forced to close or reduce hours due to the health crisis.
  • You’ve had a job offer rescinded or the start date for a new job delayed due to COVID-19.

For taxpayers who qualify, a retirement plan withdrawal can provide much-needed financial relief. But consider the long-term consequences carefully. Even if you avoid taxes by returning the funds to your account, the loss of tax-deferred growth on those funds — even for two or three years — can have a significant negative impact on your retirement nest egg.

Higher limits for retirement plan loans

The CARES Act doubles the amount of money that can be borrowed from qualified retirement plans from $50,000 to $100,000 for loans taken out on or before September 22, 2020. So, if you’ve needed to borrow money from your plans due to a financial hardship, you’ve had access to more funds, assuming your plan sponsor allows loans.

You also can delay the repayment of retirement plan loans due through the end of this year for up to one additional year. Plan loans will be re-amortized on January 1, 2021, to include the suspension period with a new repayment starting date.

Suspension of RMDs

Generally, retirement account owners over age 70½ (72 if you didn’t turn 70½ by December 31, 2019) and owners of an inherited retirement account (unless inherited from a spouse) must take required minimum distributions (RMDs) each year. For taxpayers who would normally be subject to RMDs, but prefer not to make withdrawals from their retirement plans this year, the CARES Act provides valuable relief. It suspends RMDs for 2020.

By skipping your RMD, not only will you save money on taxes this year, but you also could have more time to potentially recover losses suffered due to market volatility. In addition, because 2020 RMD amounts are based on the account’s value on December 31, 2019, if your account’s value has declined substantially since that date, taking an RMD would force you to sell a disproportionate amount of your retirement assets at depressed values.

Keep in mind that, if you had any withholding on your RMD, you’ll need to pay it back, even though you might feel that you didn’t receive it. For instance, suppose you took your $50,000 RMD and, after the $10,000 that was withheld for income taxes, you received $40,000. While you might believe, quite logically, that you only received $40,000, for tax purposes the distribution was $50,000. So, to avoid being taxed on the distribution, $50,000 must be returned to your account. The $10,000 isn’t lost; you’ll claim the withholding when you file your 2020 tax return.

Note that the payback is not an all-or-nothing proposition. Therefore, if you have spent some of the distribution or otherwise don’t have the necessary liquidity to pay back the full $50,000, don’t fret. For instance, suppose you’re able to pay back $30,000. The taxable amount will be reduced to $20,000.

The suspension applies to traditional IRAs, 401(k)s, profit sharing and money purchase pension plans, and 403(a), 403(b) and 457(b) plans. June guidance from the IRS allowed individuals who already took a 2020 RMD to return the money to their account by August 31, 2020. But the deadline could possibly be extended. Check with your tax advisor for the latest information.

More legislative relief

In addition to retirement plan flexibility, the Coronavirus Aid, Relief and Economic Security (CARES) Act also provides relief for student loan borrowers and homeowners. Individuals can stop making payments of federal student loans through September 30, 2020, without incurring penalties or late fees. No interest will accrue on these loans during this period.

Another break: Homeowners with federally backed mortgages who qualify can request loan forbearance for up to 180 days, with an additional extension of another 180 days. This request can be made regardless of any delinquency status and without incurring penalties, fees or interest.

Seek advice

The CARES Act contains numerous other provisions that could impact your personal finances. Therefore, you should talk to one of our professional tax advisors about how they could affect your situation.

© 2020

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