Can I withdraw funds from my retirement account during COVID-19? | Bowditch & Dewey
The Paycheck Protection Program money is being spent, the $ 600 temporary unemployment benefit is over, and we still need money. We could draw on our savings, sell equipment, or take out a loan for our house. Ordinarily, we wouldn’t even think about withdrawing from our retirement account while at work. However, during this pandemic, the IRS relaxed the rules so this is the first time many of us are considering retiring from our retirement accounts.
Pursuant to the CARES Act passed March 27, 2020 and the recently published IRS Notice 2020-50, “Qualified Individuals” withdrawing funds from an Eligible Retirement Account due to COVID-19 will experience special tax treatment.
The special tax treatment is generous, but do you qualify for it? Let’s take a look:
STEP 1: ARE YOU A QUALIFIED PERSON UNDER THE CARE ACT?
- You have been diagnosed with COVID-19;
- Your spouse or loved one has been diagnosed with COVID-19;
- You, your spouse, or a member of your household (someone who shares your primary residence) have suffered adverse financial consequences as a result of:
- Quarantine, vacation, or layoff or working hours reduction due to COVID-19;
- Reduction of wages (or self-employment income) due to COVID-19 or cancellation of a job offer or postponement of the start of work due to COVID-19;
- Inability to work due to lack of childcare due to COVID-19; or
- Closing down or reducing the hours of operation of a business you own or operate due to COVID-19.
If you are not a qualified individual, you will not qualify for the special tax treatment and will instead be subject to normal tax rules on loans or distributions from retirement accounts.
STEP 2: HAS YOUR RETIREMENT PLAN ADOPTED THE RULES OF THE CARES ACT TO ENABLE THE APPLICATION OF THE SPECIAL TAX TREATMENT?
Ask your pension plan administrator whether they have adopted all or some of the provisions of the CARES Act. Only the provisions of the CARES Act that you have adopted grant you special tax treatment. Otherwise you are subject to normal tax regulations.
I QUALIFY IN STEPS 1 AND 2. WHAT TYPES OF TAX TREATMENT ARE AVAILABLE TO ME?
- Increased payout amount: If you are a qualified person making a COVID-19 related withdrawal, you can withdraw up to $ 100,000 from your retirement plan in 2020.
- Loan Amount: The increased $ 100,000 special credit limit expired on September 22, 2020, meaning that the general rule of a $ 50,000 credit limit now applies, with the total credit amount capped at 50% of the employee’s vested benefits.
- Decide to include the income credited over 3 years: If you make a COVID-19-related payment between January 1, 2020 and December 31, 2020, you can state the full amount for the withdrawn year when submitting your income tax return or you can offset the income proportionally over 3 years. The amount withdrawn is taxed at the normal income tax rate, ie depending on the amount withdrawn, you can increase your normal income tax bracket in a tax year. For this reason, you can choose to include the income proportionally over 3 years in your income tax return instead of considering all income in one tax year. You should consult a knowledgeable tax advisor or tax attorney.
- Waiver of the 10% penalty for a payout before the age of 59½: You will Not are subject to customary IRS Code Section 72 (f) an additional 10% tax on the amount paid out for cashing out funds before you reach the age of 59 ½ years.
- 3 years to deposit the payment amount into your retirement account: Even if you do not intend to withdraw it or treat it as a loan too late, you can pay the money back into your retirement account within 3 years of withdrawing it. That is generous. Before the CARES Act, you only had 60 days to deposit the funds withdrawn from one of your retirement accounts into another of your retirement accounts in order to avoid taxation on the payout. Note: If you repay the money in the second or third year after the withdrawal year, you will need to file an amended income tax return to report the repayment and reduce your gross income by the amount deposited.
- Suspension of loan repayments in 2020 by your employer: If you withdrew the money as a loan after March 27, 2020 and before September 22, 2020, or if you already had a loan, you will usually have to repay the loan to the pension fund within five years. However, under the CARES Act, a qualified employer can suspend loan repayment between March 27, 2020 and December 31, 2020. If your employer suspends payments, you will not be required to make any payments on the loan during the suspension period. In addition, the term of the loan can be extended for up to one year from the date of the original repayment of the loan. Note: Interest accrues during the suspension period and loan repayments must be resumed after the suspension period has expired.
IF I CANNOT REACH ME AT STEPS 1 AND 2, IS THERE A TAX TREATMENT FOR ME?
Yes. Waiver of the 50% penalty tax for late withdrawal of RMDs: In 2020 no one is obliged to make the required minimum distributions. Typically, if you need to deduct the minimum required distributions from your retirement account in a given year, you will need to state the amount of the withdrawn funds on your income tax return in the year of withdrawal. If you have not withdrawn the required minimum distribution amount, the amount not withdrawn will be taxed at 50%. For customers who don’t need the cash, we recommend suspending the required minimum payouts in 2020.
JUST BECAUSE I CAN, DOES THAT MEAN THAT I SHOULD?
While the special tax treatment of withdrawals is generous, you should consider taking only what you need as the end result may not be what you expect. Carefully consider where the investment market is at the time of your payout. As an example, let’s say you are in the ordinary income tax bracket of 20%. In January 2020 the value of your retirement account was $ 142,857, and then in the fall of 2020 the market drops 30% leaving your account at $ 100,000. You, your spouse, or someone in your home has had negative financial consequences as a result of COVID-19. You choose to get out of the market while it’s down and withdraw the money. Thanks to the special tax break, you won’t pay the 10% penalty for the $ 100,000 withdrawal. However, you are in the 20% tax bracket for normal income taxes, which means you can pay $ 20,000 to the IRS the following year or choose to pay in installments over 3 years. Bottom Line: You pocket $ 80,000 when you had $ 142,857 of asset value, essentially losing $ 62,857 in retirement assets because you sold when the market was low and paid the taxes required.
Instead, if you are financially able and qualify for the special tax treatment, consider withdrawing the money and converting the $ 100,000 to a Roth IRA. A Roth IRA is a retirement account where you pay income tax upfront and then invest the money for life without any mandatory distribution rules. In the example above, you would pay the 20% tax on the conversion of $ 100,000 and since you have not made a withdrawal you are still invested in the same market so you can participate in the uptrend in the market at a later date. You will not have to withdraw the minimum required payouts on the Roth IRA during your life, so you can let the investment grow for as long as you wish. Note: Since the IRS does not charge the usual 20% withholding tax on a CARES Act pension payout, you can continue to use this by using your own funds to pay the tax so you can convert the entire payout amount into the Roth IRA.
* There are many harassments and exceptions to the rules. We recommend reaching out to your retirement planner and accountant or tax attorney to discuss in detail how these rules apply to you.