Retirement Tax Changes in the Cares Act

In the wake of the coronavirus (COVID-19) pandemic, tax law changes make it easier to take distributions from retirement accounts.

By , J.D.

Due to the coronavirus (COVID-19) pandemic, Congress has made several changes in the tax laws governing retirement accounts. These changes make it easier to take money out of--or keep money in--retirement accounts without incurring IRS penalties. Americans have over $30 trillion socked away in these accounts so these changes can help them weather the financial storm unleashed by the coronavirus.

Suspension of 2020 Required Minimum Distributions from Retirement Accounts

If you have a traditional IRA, SEP-IRA, SIMPLE IRA, 401(k), 403(b), or 457(b) retirement plan, you have to withdraw a minimum amount each year once you turn 72. This is called the required minimum distribution, RMD for short. The deadline for taking RMDs is December 31 each year.

The minimum amount you must withdraw is based on your life expectancy and that of a beneficiary. IRS tables show you how much you must withdraw. If you fail to take your RMD, the IRS charges you a penalty equal to half (50%) of your RMD. This is one of the biggest of all IRS penalties.

Most people 72 and over who have retirement accounts--more than 80%--take out more than the amount of their RMD every year. They need the money to live on. However, with historic declines in the stock market and other investments, you might not want to take your RMD at all in 2020 in the hope that your retirement investments will rebound in value in 2021.

Fortunately, Congress has acted to allow you to do just that. The recently enacted Coronavirus Aid Relief and Economic Security Act (CARES Act) allows people 72 and over to suspend their RMDs for one year. In other words, you can delay taking your RMD until 2021. The one-year delay applies to both 2019 RMDs that needed to be taken by April 1, 2020 and 2020 RMDs.

What if you already took your 2020 RMD? You can't put the money back in the same account. However, if you put the money into a new IRA within 60 days, the amount won't be taxable. This is called an IRA rollover.

Penalty-Free Withdrawals from IRAs, 401(k)s, and Other Retirement Accounts

The CARES Act also provides tax relief if you need to take money out of your retirement account and are under 59.5 years of age. Ordinarily, you have to pay a 10% penalty if you take the money out before you reach age 59.5—this is on top of paying ordinary income tax on the withdrawal.

The CARES Act permits you to take a "coronavirus-related distribution" of up to $100,000 in 2020 without paying the penalty. You can take such a penalty-free distribution if:

  • you, your spouse, or a dependent are diagnosed with SRS-COV-2 or COVID-19, or
  • you experience adverse financial consequences due to being quarantined, furloughed, laid off, having reduced housing, having work hours reduced, or being unable to work due to lack of child care.

All retirement accounts fall under this rule: IRAs, Roth IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, pension plans, 457 plans, and 403(b) plans.

Most Americans under 59.5 who have been affected by the coronavirus pandemic will qualify for such penalty relief. Moreover, you don't have to provide a doctor's note or other proof to your plan administrator—a certification made by you is sufficient.

Paying Taxes on Early Distributions

You must still pay regular income tax on such a distribution, but you have three years to do so, instead of the normal one year. The repayment period begins in 2020. However, if you repay the entire amount you withdraw within three years, you don't have to pay any tax at all on the distribution. You can make multiple payments over the three years or a single payment at any time. If you do this, your withdrawal is in effect an interest-free loan.

Borrowing Money from Your Retirement Account

If you have a 401(k), solo 401(k), or 403(b) retirement plan, you may be allowed to borrow money from it. Check with your plan administrator to make sure. Note that you are not allowed to borrow from an IRA or SEP-IRA.

Borrowing from a retirement account can be an attractive option because you need pay no income tax on the loan as long as you pay it back within five years. You must also pay interest on the loan (the interest goes into your retirement account). You need to make your loan payments at least quarterly in substantially equal amounts. If you don't pay the loan back on time, it's treated as a distribution and you'll have to pay income tax on it and any applicable penalties.

There is an annual limit on how much you can borrow. The normal rule is that you can borrow up to 50% of your vested account balance up to $50,000. The CARES Act has increased this amount to $100,000 until September 23, 2020 and removed the 50% of account balance limitation. Thus, for example, if you have $100,000 in your 401(k), you can borrow $100,000. If you have $200,000, you can borrow $100,000. If you have $50,000, you can borrow $50,000. You can take as many loans as you want as long as the total doesn't exceed $100,000.

You qualify for the $100,000 loan limit if you've suffered adverse financial consequences from the coronavirus pandemic. This is identical to the rule for making penalty-free early withdrawals described above.

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