How Does the Coronavirus Emergency Relief Package Impact You, Part 2: Modified Retirement Account Rules

In yesterday’s post on the Coronavirus Aid, Relief, and Economic Security (CARES) Act, we discussed the cash distributions that the government will send within the next month or two.  In this post, we will discuss key provisions related to the treatment of retirement accounts this year.

RMD Waiver.  The CARES Act grants a waiver for 2020 of the need to take Required Minimum Distributions (RMDs) from retirement accounts, such as 401(k)’s and IRAs.  Therefore, any individuals who don’t need to draw from their retirement accounts to fund their living expenses (or, don’t need to draw the full amount of their RMD) are not required to do so.  This will enable them to save on income taxes and potentially avoid the need to sell equities after the significant drop in the market last month.  This applies to Beneficiary IRAs for decedents who passed away in 2019 or earlier as well.

• Planning Opportunity:  There is no provision in the law for putting back funds already withdrawn to fulfill one’s 2020 RMD.  However, if the withdrawal occurred within the last 60 days, the gross amount can be returned to an IRA and considered as a 60-day rollover.  The taxes would be refunded on one’s 2020 tax return.
• Personal vs Societal Well-Being:  The law doesn’t change one’s ability to make Qualified Charitable Distributions (QCDs) from an IRA after age 70 ½.  This remains a tax-efficient way of giving to charity.  From a tax planning perspective, it may be advantageous to wait on QCDs until 2021 when they could again fulfill part of one’s RMD obligation.  However, if the QCDs are going to a charity that could particularly benefit from additional funding in the current crisis, you may want to consider still giving in 2020 to help those in need when they need it most.

Exception for Early Withdrawals.  The CARES Act allows a new exception for early withdrawals from an IRA or other retirement account prior to age 59 1/2 for individuals who are diagnosed (or whose spouse or dependent is diagnosed) with COVID-19 or who are experiencing financial hardship in light of the pandemic.    An individual can withdraw up to $100k without the 10% early withdrawal penalty.  One would still be liable for income taxes on the withdrawal, but the tax can be spread over three years. Alternatively, one can return the funds to the account within three years and receive a refund for any income tax paid by filing an amended tax return.

• Planning Opportunity:  We are generally wary of taking withdrawals from retirement accounts early (even with the intention of replenishing them) unless it is absolutely necessary.  If this might apply to you, please be sure to discuss your options and strategy with a trusted adviser.  Some advisors have also suggested that this provision could be used to move funds from a current retirement plan to an IRA— e.g., if the investment choices or fees in your current plan are not optimal.  This is a risky move, however.  First, you need to be able to prove some level of financial need in case of an IRS audit.  Second, the rolled over funds would spend some time out of the market, and, especially at a time of high market volatility, potentially losing out on a market upswing might be more detrimental to your retirement nest egg than sticking with subpar investment choices and fees.

Changes to Retirement Plan Loans.  The CARES Act also increased individuals’ ability to obtain needed funds through a retirement plan loan.  Many 401(k)’s and 403(b)’s, for example, allow for this option.  The CARES Act increased the maximum loan amount from $50k to $100k, increased the maximum percentage of one’s vested balance that one can take as a loan from 50% to 100%, and allowed for a delay on payments due in 2020 for up to one year.  The advantages of using retirement plan loans for cash needs are that they generally involve a quick and painless approval process, the interest rate is relatively low (and, in fact, you pay yourself the interest), and you can usually pay the loan back over a relatively long timeframe (e.g. five years).  The drawbacks are:  (1) the interest payments will be made with after-tax dollars but will be taxed again when you withdraw money from the account in retirement, (2) the funds withdrawn are no longer invested and will potentially miss the expected market rebound, and (3) if you leave your job and/or can’t repay the loan for other reasons, the IRS will treat it as a withdrawal from the account (i.e. the balance of the loan will be included in your taxable income that year).  If the loan balance is treated as a withdrawal in 2020, however, the consequences are less severe than usual, since the early withdrawal penalty may be waived.

• Planning Opportunity:  Depending on the level of assets in your current retirement plan versus other retirement accounts and whether the coronavirus may impact your current job or level of income, taking a retirement plan loan may be preferable to taking an early distribution from retirement accounts as an income source of last resort.  Again, please call us to discuss the options if you find yourself in serious need of income.

In addition to these changes to retirement account rules stemming from the CARES Act, note that the IRS also altered its retirement account rules for this year.  When it extended the tax filing deadline to July 15^th, it also extended the deadline for contributing to a traditional IRA or Roth IRA accordingly.

Please stay tuned for our final blog post on CARES Act provisions aimed at providing cash flow relief later this week, and again please call or email us with any financial concerns during this difficult time.