Congress has passed an 880-page law called the Coronavirus Aid Relief and Economic Security Act (CARES Act). The CARES Act contains many tax relief measures. These include several for taxpayers who have money in retirement plans.
If you have a retirement plan, take careful note of these changes. For some people, they represent a once-in-a-lifetime opportunity to get money out of their retirement plans without paying taxes.
If you have an IRA, 401(k), or another tax-qualified retirement plan, you’re not supposed to take your money out until you reach age 59 ½. If you make an early withdrawal, you must pay a 10 percent tax penalty on top of regular income tax.
The CARES Act permits you to withdraw up to $100,000 from your plan during 2020 without paying the 10 percent penalty. But, to be penalty-free, the withdrawal must fall under at least one of the following reasons:
There are no income limits on who can make such withdrawals. And you can use the money for any purpose.
It’s likely most people qualify for penalty-free withdrawals under one or more of these grounds. By the way, you don’t have to provide a doctor’s note or other proof to your plan administrator when you make your withdrawal.
You can make your withdrawal in one lump sum or take several smaller withdrawals up to $100,000 during 2020. If you have more than one retirement plan, you can make withdrawals from each up to the $100,000 aggregate limit.
You can’t make such withdrawals after 2020.
Ordinarily, when you withdraw money from a retirement plan (other than a Roth IRA or Roth 401(k)), you must pay all the tax due that year.
However, the CARES Act gives you three years to pay the income tax on your up to $100,000 2020 withdrawals. You can spread your tax payments equally over the three years, starting in 2020.
Here’s the kicker. You don’t have to pay any tax at all on your withdrawal if you pay the entire amount back within three years of the withdrawal date.
Plus, you can pay the money back in a lump sum or with multiple re-contributions.
In effect, the CARES Act allows you to take an interest-free loan of up to $100,000 from your IRA, 401(k) or another plan. All you have to do is pay the money back in three years. This allowance is an unprecedented tax break.
Instead of withdrawing $100,000 from your plan, you may be able to borrow it. But you can’t borrow from all retirement plans. For example, you can’t borrow from an IRA or SEP-IRA.
However, your 401(k), solo 401(k) or 403(b) retirement plans are sources for self-loans. It’s always a good idea to check with your plan administrator to make sure.
No tax is due on loans from a retirement plan provided that you repay the loan within five years. You must also pay interest on such loans. In this case, you pay the interest to yourself since it goes into your retirement plan.
What happens if you don’t pay the money back? The straight answer is that you have to pay tax on it. If you took out the money before age 59½, you’d also have to pay a 10 percent tax penalty.
There is an annual limit on how much you can borrow from a retirement plan. The standard rule is that you can borrow up to 50 percent of your vested account balance up to $50,000.
The CARES Act has doubled this amount to $100,000 and removed the vested balance requirement. So, you can borrow up to $100,000 if you have that much in your plan.
But, you must borrow the money by September 23, 2020. And, must have suffered adverse financial consequences from the coronavirus pandemic. These stipulations are identical to the rule for making penalty-free early withdrawals described above.
Is there any advantage to borrowing up to $100,000 instead of withdrawing the same amount and then paying it back tax-free? The only real advantage appears to be that you have five years to pay the loan back without tax consequences. You have only three years to pay back an up to $100,000 withdrawal.
If you’re over 72, you probably know about the dreaded RMD. This is short for required minimum distribution. In effect, this is the minimum amount you must withdraw each year from your traditional IRA, SEP-IRA, SIMPLE IRA, 401(k), 403(b), or 457(b) retirement plan.
You base your RMD amount on how long the IRS expects you to live. If you don’t take your RMD each year, the IRS charges you a penalty of 50 percent of your RMD amount. As such, not withdrawing the minimum is one of the most dreaded of all IRS penalties.
The CARES Act allows you not to take your RMD for 2020. You might want not to do so if your retirement investments have considerably declined in value during the year. They may be back up by next year. Let’s hope so.