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The CARES Act
Changes for IRAs and Retirement Plans
The Coronavirus Aid, Relief, and Economic Security or CARES Act, is a massive relief package passed by the U.S. government in March. While you are probably aware of $1,200 stimulus payments made to many Americans, the Act also added relief opportunities in other ways. Some of these changes came within your retirement plans or IRAs.
One change came in the form of a temporary suspension to Required Minimum Distributions (RMDs) for year 2020. RMDs are required annual withdrawals that the IRS makes you take upon attaining age 72 (or age 70½ for those who turned 70½ before January 1, 2020). As an example, take an individual who is age 75 and has a million dollar IRA as of the end of 2019. This year his RMD would have required him to take $43,668 out of his IRA. This would be taxed as ordinary income for 2020. Additionally, he would have to sell investments, potentially at lower asset prices, to fund the RMD. For someone in a high tax rate, more than 40% of this money could have gone to Federal and State of N.J. in the form of taxes. By having this RMD suspended, this individual is able to keep his 2020 tax bill considerably lower while also keeping more money invested in his IRA.
The CARES Act also allows qualified individuals to take a penalty-free distribution from their employer sponsored retirement plan or from their IRA if you are under the age of 59½. Typically, individuals under 59½ pay ordinary income taxes, plus a 10% penalty or excise tax for tapping into these funds prior to retirement. The CARES act eliminates this penalty in 2020 making it cheaper for qualified individuals to access funds.
Two key parts to consider include what is a “qualified individual” and how exactly would the taxes on this distribution work? To be a “qualified individual” you generally would have had to have experienced adverse financial consequences or been diagnosed with COVID-19. The IRS provides specific guidance that can be found at: irs.gov/newsroom/coronavirus-related-relieffor-retirement-plans-and-iras-questions-and-answers.
Taxation of your distribution will depend on how you report it and you have two options. Your first option would be to report the entire distribution for 2020. This is straightforward and things would work the way they usually would if you were to pull money from your IRA or employer sponsored plan. The CARES Act also allows you to report the distribution “ratably over a three-year period.” Therefore, if you take $30,000 this year, you could report $10,000 in 2020, 2021, and 2022. Whether or not it makes sense to report the income this year, or over a three-year period, will depend on your individual situation so speak to your CPA if you do decide to take one of these distributions this year.
Loans from employer-sponsored plans have also increased to a maximum of $100,000, raised from a previous $50,000 limit. While taking a loan and borrowing from yourself sounds like a nice idea, make sure you understand how this process works before you proceed. Paying back the loan is typically done through your paycheck, so this could put a bit of a crunch on your monthly cash flow as you make payments on the loan. The other thing to consider is that if you take $100,000 out of your 401(k), you will have less earnings power and you may be selling investments low in order to fund your $100,000 loan. Furthermore, if you leave your employer, depending on the plan rules, you may have to pay back the loan in around three months or it would be reclassified as a withdrawal (subject to taxes and yes maybe a 10% penalty tax). Therefore, while these 401(k) loans may sound like a good idea, they often can put people in a further hole. As always, try to keep your money invested for the long-term. With interest rates as low as they are, finding alternate means of financing may make sense.
The CARES Act was a massive piece of legislation and with it, several relief opportunities do exist. Having a discussion with a knowledgeable financial professional can help you learn whether any of these opportunities could benefit you. n
Tom Reynolds, CPA & Matt Reynolds, CPA, CFP ® Robert T. Martin, CFA, CFP ® Gordon Shearer Jr., CFP ® Jeff Hilliard, CFP ® , CRPC Joseph McCaffrey
This article is for informational and educational purposes only and should not be relied upon as the basis for an investment decision. Consult your financial adviser, as well as your tax and/or legal advisers, regarding your personal circumstances before making investment decisions.
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