Similar to disaster relief bills of the past, The Coronavirus Aid, Relief, and Economic Security (CARES) Act (H.R. 748) or the (“Bill”) adds flexibility to the use of retirement funds by waiving the 10 percent early withdrawal penalty for distributions up to $100,000 from qualified accounts for COVID-19-related purposes made on or after January 1, 2020, waiving the required minimum distribution rules for certain defined contribution plans and IRAs, and provides flexibility for loans from certain retirement plans for coronavirus-related relief.
Waiver of the 10 Percent Early Withdrawal Penalty for Distributions up to $100,000
Normally, any distribution from a qualified retirement plan to an individual that is made before the individual attains age 59½ is subject to 10 percent tax penalty as an early withdrawal.
However, this penalty does not apply if the distribution is: (a) properly rolled over into an IRA or another qualified retirement plan; (b) made following employment termination and the individual has attained age 55; (c) made as a loan to the individual; or (d) made pursuant to a s Order.
Here, the 10 percent early withdrawal penalty for distributions up to $100,000 from qualified accounts for COVID-19-related purposes made on or after January 1, 2020 is waived. In addition, income attributable to such distributions would be subject to tax over three years (rather than taxed in the year of withdrawal), and the taxpayer may recontribute the funds to an eligible retirement plan within three years without regard to that year’s cap on contributions.
What is a Qualifying Distribution?
A coronavirus-related distribution is a distribution made to an individual: (1) who is diagnosed with the virus SARS-CoV-2 or with the coronavirus disease COVID-19, (2) whose spouse or dependent is diagnosed with SARS-CoV-2 or COVID-19, or (3) who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, being unable to work due to lack of child care due to SARS-CoV-2 or COVID-19, closing or reducing hours of a business owned or operated by the individual due to SARS-CoV-2 or COVID-19, or other factors as determined by the Treasury Secretary.
Temporary Waiver of Required Minimum Distribution (RMDs) Rules For Certain Retirement Plans And Accounts
This Bill amends IRC §401(a)(9), to temporarily waive, for the 2020 calendar year, the required minimum distribution rules for certain defined contribution plans and IRAs ,and also provides relief to individuals who would otherwise be required to withdraw funds from such retirement accounts during the COVID-19-related economic slowdown. The Secure Act retirement system overhaul passed earlier this year raised the age for RMDs to 72, but if you turned 70½ last year you would have still needed to pay RMDs this April. The ACT gives those meeting RMD age the option to not take required minimum distributions in 2020. This provision has the potential to benefit many retirement age individuals, particularly those still working because RMDs are calculated based off account balances as of the end of the prior year, and stock markets were at a near record highs at the end of December 2019.
Hardship Withdrawals and Loans
The Bill allows larger loans against the money saved in workplace retirement plans (e.g., 401(k) plans). Normally, you can borrow only up to $50,000 or 50% of your vested account balance, whichever is less. Eligible individuals can now withdraw up to $100,000 from their retirement accounts, in total, or 100% of the participant’s vested account balance in the plan without penalty as long as they pay back the distributions within three years. Individuals with a loan outstanding from their plan with a repayment due from the date of enactment of the Cares Act through Dec. 31, 2020, can delay their loan repayments for up to one year.
It is important to remember that plan loans follow different rules than withdrawals and you should always talk with your HR department or obtain a copy of your plan document from your plan administrator to make sure that plan loans are even allowed. If they are allowed by your plan, following are some things to consider:
• Does your plan allow hardship loans? If so, what sort of hoops and hurdles does the plan document require before you are able to borrow against your vested amount?
• If you fail to repay the loan, know that it’s treated as a distribution and subject to taxes and you will be issued a 1099. Moreover, if you leave or lose your job, you may be required to pay back the balance early, or owe taxes and, possibly, an early-withdrawal penalty.
• If you are planning on going through a divorce or in the midst of a divorce who is going to assume the loan, or will it be considered a marital debt?
Consult your tax advisor for any income-tax related questions.
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