CPA Chats: RETIREMENT PLANS & the CARES Act
Let’s chat about another little known type of relief that was included in the CARES Act. If you missed my previous posts in this series, you can find them on this page or on my website. I’ve been deep diving into some of the lesser known financial & tax relief efforts that were included in the Coronavirus Aid, Relief, and Economic Security (CARES) Act.
As many know, if you withdraw money from your 401(k) before you're 59½, the IRS usually assesses a 10% penalty when you file your tax return. However, this penalty has been waived to help fund adverse financial outcomes due to COVID-19.
Here are the details.
Up to $100,000 from qualified retirement plans (certain employer retirement plans, such as section 401(k) and 403(b) plans, and IRAs) can be taken out any time during the 2020 calendar year (through 12/31/2020) due to coronavirus-related hardships, without being subject to the traditional 10% penalty. The CARES Act refers to this withdrawal as a “coronavirus-related distribution.”
However, there are specific requirements that must be met in order for that penalty to be waived. The distribution must be made to an individual (or the spouse or dependent of an individual) diagnosed with the SARS-CoV-2 or COVID-19 by a CDC-approved test, or an individual who incurs financial difficulty from the virus. The listing they have provided that details “financial difficulty” is below:
- Adhering to quarantine orders.
- Being furloughed, laid off, or having work hours reduced due to such virus or disease.
- Being unable to work due to lack of childcare due to such virus or disease.
- Closing or reducing hours of a business owned or operated by the individual due to such virus or disease,
- Other factors as determined by the U.S. Secretary of the Treasury.
The IRS website says they have received comments from the public and will consider expanding this listing based on those comments when they offer more detailed guidance in the future.
So, one could assume these existing criteria apply to almost every single American family with a retirement account. However, I do encourage anyone to take extra care (without a confirmed positive test) to document your qualifications/criteria if you plan to use this relief option. Obviously, withdrawing any retirement savings is never ideal & one of the last options I would ever recommend to any client. However, I recognize these are tough economic times & I wanted to share this information as it may be valuable in keeping food on many tables & a roof over many heads.
One more note from research I have found: CARES Act does not require that your employer follow these new withdrawal and loan rules. Thus, employers have the option to adopt these new rules. If you’re hoping to make a withdrawal from an employer sponsored plan and you meet these eligibility requirements, I encourage you to ask your plan sponsor first. Just because you meet one or more of the eligibility requirements listed above does not automatically mean you will be able to access money in your workplace retirement accounts.
As with many of the provisions in the CARES Act, the IRS hasn’t issued much detailed guidance yet. However, the Treasury Department and the IRS are formulating guidance on section 2202 of the CARES Act and anticipate releasing that guidance in the near future.
Now, let’s chat about the tax treatment of coronavirus-related distributions. A coronavirus-related distribution is a distribution that is made from an eligible retirement plan to a qualified individual from January 1, 2020, to December 30, 2020, up to an aggregate limit of $100,000 from all plans and IRAs. These distributions aren’t subject to the penalty (10%) however, they are still subject to income tax.
From the IRS: “The distributions generally are included in income ratably over a three-year period, starting with the year in which you receive your distribution. For example, if you receive a $9,000 coronavirus-related distribution in 2020, you would report $3,000 in income on your federal income tax return for each of 2020, 2021, and 2022.”
You do also have the option of including the entire distribution amount in your taxable income for 2020 if you choose. Lastly, you also have the option to repay a portion or the total amount of the coronavirus-related distribution within 3 years after the date the distribution was received and thus would not owe federal income tax on the amount repaid. They are essentially treated as tax-free rollovers if distributions are repaid. The IRS offers more examples of this process in their FAQ link below. At this time, there are no limits in place on how you can use the funds.
A little tip from your friendly neighborhood CPA: The one-rollover-per-year rule still applies, so a taxpayer who made a rollover within the last 12 months will need to carefully time the 2020 coronavirus distribution to remain eligible for the three-year rollover provision in the CARES Act.
Now, let’s chat about relief for those subject to required minimum distributions. Any required minimum distributions (RMDs) that were supposed to be taken in 2020 are now suspended for tax year 2020, including taxpayers who turned 70 ½ in 2019 but did not withdraw their first RMD by Dec. 31, 2019. You do not have to prove any eligibility or adverse effects by COVID-19 to defer these distributions.
There are a few other relief options included in this package as it relates to loans against retirement plans. Certain loan repayments may be delayed for one year and loan limits may be increased. The CARES Act also permits employers to optionally increase the maximum loan amount available to qualified individuals.
Here is a great FAQ link on the IRS website for more information on this topic:
https://www.irs.gov/newsroom/coronavirus-related-relief-for-retirement-plans-and-iras-questions-and-answers