The first half of this year was brutal and included a nationwide lockdown and quarantine to our homes. The pandemic has driven mass layoffs in numbers that are hard to believe. Thankfully, the jobs are beginning to come back, and our economy is taking baby steps to reopening. However, for many families this has been a near insurmountable financial hardship, and they are looking for ways to pay the bills and considering a withdrawal from their 401(k) or IRA. Thankfully, the CARES Act has supplied us with a way to do this without the stiff penalty that would normally accompany an early withdrawal.
The CARES Act was written and designed to provide economic relief to individuals and businesses affected by the COVID-19 pandemic. Most people know this act as the one that gave us our stimulus checks, but it has further implications for individuals particularly in regard to your retirement accounts. As I mentioned above, many are looking to their retirement accounts as a potential vehicle to pay the bills until they can back to work. Obviously, this is not ideal, but it is an option and it is one that the CARES Act makes a little bit more manageable.
Normally, if you withdraw from a Traditional IRA or 401(k) prior to age 59 and a half you will pay a 10% penalty in addition to taxes and 20% will automatically be withheld for federal taxes unless you indicate otherwise. State tax is also withheld in many states. The CARES Act has done away with this penalty for the year 2020 and is also giving you the option to pay taxes on your withdrawal spread out over the next three years. The one caveat is that penalty free withdrawals are limited to $100,000 across all of your retirement accounts.
In addition, you will also have the ability to re pay your distribution over the course of three years. If you are able to accomplish that, then you will not owe any taxes on your original distribution. For example, if you withdraw $10,000 and re contribute $10,000 over the next three years you will not owe taxes on that distribution. And if for some reason you are only able to pay back a portion of your withdrawal, you only pay taxes on what you keep. Should you decide to include the withdrawal in your income and also re pay the withdrawal within 3 years, the IRS has a provision for that as well. The IRS states that:
“[If] you choose to include the distribution amount in income over a 3-year period (2020, 2021, and 2022), and you choose to repay the full amount to an eligible retirement plan in 2022, you may file amended federal income tax returns for 2020 and 2021 to claim a refund of the tax attributable to the amount of the distribution that you included in income for those years, and you will not be required to include any amount in income in 2022.”[i]
However, the IRS does put a limit on who can take advantage of this opportunity although it is a broad demographic. The IRS qualifies an individual for a coronavirus-related distribution as follows:
- You are diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention;
- Your spouse or dependent is diagnosed with SARS-CoV-2 or with COVID-19 by a test approved by the Centers for Disease Control and Prevention;
- You experience adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced due to SARS-CoV-2 or COVID-19;
- You experience adverse financial consequences as a result of being unable to work due to lack of child care due to SARS-CoV-2 or COVID-19; or
- You experience adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to SARS-CoV-2 or COVID-19.
The decision to withdraw from your retirement accounts should not be taken lightly and you should discuss all of your options with your financial advisor. If you have further questions or are just looking for guidance, let me know! I am more than happy to help!
I almost forgot to include a song of the week, which I know for many of you, is the only reason you read this blog. I have come to peace with this and will do my best to bring your life a little bit of musical culture. But I am just a man, so please accept my humble recommendation below.