The CARES Act Eases Retirement Account Rules During COVID-19

It should be a last resort, but understandably, people are looking to their retirement plans as a source of cash to get through the pandemic.

The Coronavirus Aid, Relief, and Economic Security (Cares) Act includes several provisions that cover retirement accounts. The act temporarily increases how much you can borrow from your retirement and waives the penalty for an early withdrawal.

Let’s take a closer look at the retirement-related provisions in the CARES Act, and see which of them could help you cope with financial stresses stemming from the COVID-19 crisis.

First things first: Not all tax-advantaged retirement account holders can take advantage of the CARES Act’s relaxed early distribution and loan provisions. Specifically, the legislation restricts relief to qualified participants with a valid COVID-19 related reason for early access to retirement funds. These include:

  • Being diagnosed with COVID-19
  • Having a spouse or dependent diagnosed with COVID-19
  • Experiencing a layoff, furlough, reduction in hours, or inability to work due to COVID-19 or lack of childcare because of COVID-19
  • Have had a job offer rescinded or a job start date delayed due to COVID-19
  • Experiencing adverse financial consequences due to an individual or the individual’s spouse’s finances being affected due to COVID-19
  • Closing or reducing hours of a business owned or operated by an individual or their spouse due to COVID-19

Be aware of the fact that you will be required to prove that COVID-19 affected you personally if you want to take advantage of the CARES Act provisions.  Without a valid Coronavirus-related condition, you’ll need to play by the standard rules.

But even if you meet one or more of these eligibility requirements, that does not necessarily mean you will be able to access money in your workplace retirement accounts. That’s because the CARES Act does not require employers to follow the new, more permissive withdrawal and loan rules. Fidelity Investments, for example, says it expects the vast majority of plans it administers to adopt the new rules.

Ask your plan sponsor first.  Not all retirement plans will accept the CARES Act provisions for COVID-19 related hardships.  The provisions are entirely within the purview of the retirement plan, so participants must check first to see what their plan sponsor offers.

How does the CARES Act relax early distribution rules?

The CARES Act allows eligible participants in certain tax-advantaged retirement plans — including 401(k)s, 403(b)s, 457s, and Traditional IRAs — to take an early distribution of up to $100,000 during calendar year 2020 without paying the 10% penalty tax the law imposes on most retirement account withdrawals before an account owner is 59 1/2. Note that this is $100,000 in total, per person, no matter how many retirement accounts you have.

In addition, the act suspends the mandatory 20% tax withholding requirement that normally applies to early distributions from a 401(k) or other workplace retirement plan. (There is no withholding requirement on early withdrawals from IRAs.)

Keep in mind that withholding isn’t a tax, but rather the IRS’s way of ensuring you ultimately pay whatever ordinary income tax you end up owing on withdrawals. Be aware that this aspect of the reform could create a potential tax landmine down the road if you don’t plan ahead.  Just because there is no mandatory 20% withholding from an early distribution, as would normally be the case, does not mean that people won’t owe taxes.  Plan appropriately to be able to pay your taxes.

The CARES act gives you extraordinary flexibility to manage the resulting tax liability. You can choose to spread the taxes owed over three years, or pay it all in 2020 if your income (and thus your tax rate) is much lower this year.

Alternatively, the CARES Act gives you up to three years to redeposit the withdrawn money into a retirement account — normally you’d have only 60 days. If you restore the retirement funds within three years, you won’t owe tax until you take distributions in retirement. You may, however, have to file an amended tax return to get back any tax you paid before redepositing the funds into retirement savings.

On June 19, the IRS published Notice 2020-50 to help individuals navigate relief options. The notice, titled Guidance for Coronavirus-Related Distributions and Loans From Retirement Plans Under the CARES Act has detailed examples of how distributions and recontributions under the expanded rules works as well as safe harbor information for loan deferrals

The CARES Act enhanced loan rules

Under normal circumstances, owners of certain workplace retirement accounts — including 401(k)s, 403(b)s, and 457 plans — are allowed to  borrow up to $50,000 or 50% of their vested balance, whichever is less, from the account. Your employer doesn’t have to permit retirement plan loans, but most do. Recall that the loans may be used for any purpose whatsoever.

The CARES Act bumps the legal loan limit up to 100% of the vested balance or $100,000, whichever is less This option is available for any loans taken out during the six-month period from March 27, 2020 to September 23, 2020.

Participants must repay standard retirement account loans within five years, and you can generally expect to start repaying immediately (and remember, you’re repaying the principal and most of the interest to yourself). The CARES Act allows borrowers to forgo repayment during 2020, and starts the five-year repayment clock in 2021, giving borrowers an extra year to repay their loans. The loan will, however, continue to accrue interest in 2020.

What if you lose your job after taking a loan?

Up until the Tax Cuts and Jobs Act (TCJA) took effect in 2018, loans from eligible retirement plans typically had to be repaid within 60 days of losing your job or changing employers, or they would be considered taxable distributions. However, the TCJA extended the repayment deadline in case of job loss to the day your federal tax return is due for that calendar year — with extensions. So for instance, under TCJA, if you lose your job at any time in 2020 after taking a loan from your 401(k), you have until October 15, 2021 to repay the borrowed money into a retirement account, if you don’t want it to be treated as a taxable distribution.

In addition, it’s important to remember that not all retirement plan sponsors allow loans and they don’t have to. Each retirement plan’s rules and requirements supersede the CARES Act. Your plan has to elect it for you to be eligible.

The CARES Act suspends RMDs for 2020

The CARES Act has suspended required minimum distributions (RMD) for 2020. Before, individuals over the age of 70½ (for those born prior to July 1, 1949) or 72 (for those born after July 1, 1949) were required to take a minimum distribution from their tax-deferred retirement accounts each year. In addition to retirees, most non-spousal heirs who inherited tax-deferred accounts, no matter their age, were also required to take an annual RMD.

If you’ve already taken your 2020 RMD, a recent adjustment to the CARES Act means you had until August 31 to put the RMD funds back into your account.  In addition, you do not have to consider the RMD you took out as your single yearly rollover distribution. You can still take out a separate rollover distribution for some other purpose.

Should you withdraw funds from your retirement accounts?

The changes to the rules governing tax-advantaged retirement accounts are an unusual response to an extraordinary situation. The rules have been altered and relaxed in order to give financial flexibility to people when they need it most.  But it’s still wise and prudent to tread carefully. If you must dip into your retirement savings, figure out the minimum you need.  Don’t take out as much as you can.  Only take out as much as you need.

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