04/08/2020
The recently enacted COVID-19 stimulus package, the CARES Act, not surprisingly included temporary changes to the tax code related to waiving the 10% penalty on qualifying distributions from retirement accounts for those under 59 1/2 years. Additionally, the CARES Act waives the requirement that individuals take an RMD distribution from their retirement accounts during 2020. Finally, the CARES Act provided temporary changes to loans you can take against your retirement account.
10% PENALTY: The CARES Act waives the 10% penalty for early distributions (distributions taken before a plan participant reaches 59 1/2 years of age) for qualifying distributions taken between 01/01/2020 and 12/31/2020. The following are the type of retirement accounts you may take a qualifying distribution penalty free: IRAs, ROTH IRAs, SEP IRAs, Simple IRAs, 401(k)s, pension plans, 457 plans, and 403(b) plans.
Who qualifies for these early distributions that will avoid the 10% penalty? The retirement plan document may have language in them that may impact your ability to take a penalty-free distribution. Therefore, you will need to consult with your retirement plan administrator.
Generally, individuals who will qualify for the penalty-free distributions from retirement accounts are those that: (1) are subject to quarantine; (2) are furloughed or laid off from employment; (3) self-employed business owners who had to close their business or had to reduce the number of business hours worked; (4) are unable to work due to childcare changes and availability; (5) are either diagnosed with COVID-19 or someone in their immediate family (spouse, children) are diagnosed with COVID-19.
While the distributions will not incur a 10% penalty for those under 59 1/2 years, the distributions will be taxed as ordinary income, unless you pay the distribution back to your retirement account. If you do take a retirement account distribution, the CARES Act provides that you can spread the income over 3 years for income tax purposes. The Treasury Dept. is still working out the regulations on how this will be accomplished. If you take a distribution from your retirement account and later you determine that you do not need the money, then you may repay the money to the retirement account and you will not be required to treat the distribution as taxable income. You have 3 years to repay the money in order to avoid incurring a taxable distribution.
RMDs for 2020: The required minimum distribution rules have been waived for 2020. This is because RMDs for the current year are calculated based on the value of the retirement account at the start of the year. The DOW is down about 25% since the beginning of 2020. Therefore, the CARES Act provides relief for the loss in value and waives the requirement that you must take RMD during 2020, allowing that money to stay in your retirement account during 2020 and hopefully increasing in value as the DOW recovers its losses.
LOANS FROM CERTAIN RETIREMENT ACCOUNTS: Anyone who has a 401(k) or 403(b) retirement account may take a loan out on their retirement account. The maximum amount of the loan(s) that may be taken out is $100,000 or 100% of the value of your retirement account if your retirement account balance is less than $100,000. You only have between March 27, 2020 and September 23, 2020 to borrow money against your retirement account.
These loans are not available for people who have IRAs, SEP IRAs, or 401(k)s from a former employer as these types of retirement accounts do not allow for loans. If you are self-employed and you have an IRA or a SEP IRA, you can set up an individual 401(k) plan, then roll over money from your IRA or SEP IRA into your newly created individual 401(k) account and then take out a loan.
Fair, arms-length loans include interest rates on the loans. That is the case for loans against your retirement accounts, as well. The interest rate that the IRS requires for a true loan transaction on retirement account loans is between 5% and 5.5%
So long as you pay back the loan pursuant to a customary amortization schedule tracking payments of principal and interest, you will not be assessed a 10% penalty on the loan or have to treat the loan proceeds as taxable income. If you miss 1 monthly payment, the IRS provides for a grace period. However, if you miss 2 or more payments, the IRS will deem the loan as a distribution from your retirement account (rather than a loan) and you will then be subject to the 10% penalty rules if you are under 59 1/2 years and you will have to treat the loan as a taxable distribution on your tax return.
Hopefully, no one will feel the need to take a loan against their retirement account because of the loss of compounding interest that just can't be recovered as you continue to save money for your retirement.
Stay safe.
