The last thing Shelly wanted to do was withdraw funds from her IRA.
It was the one account she had prioritized as she moved forward after her divorce. To her, it meant she was serious about taking care of herself so she wouldn’t someday be a burden on her kids. But Corona changed all that: first, her work hours were cut back. And then, her ex stopped paying child support because his income was cut, too.
Now it was survival time. Shelly had read that the CARES Act had made it easier to take money out of IRAs, and maybe even be able to put some back tax-free over time. What she needed most was clarity to know the best way to do so.
Corona rarely presents us with standalone obstacles. They usually come with complications or multiple factors that make decisions more difficult.
The decision to take money out of a retirement account is no different.
We know that, under normal circumstances, if we decide to withdraw funds from an IRA – where we contributed pre-tax dollars – we’ll have to pay the income taxes on the amount withdrawn.
And if we’re below age 59 at-1/2 the time of withdrawal, we’ll also have to pay a 10 percent penalty.
What the CARES Act changed
In late March 2020, it was clear the pandemic would change the finances of countless Americans. Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act. Among other things, it includes measures that can help people holding IRAs and other kinds of retirement accounts, such as 401(k)s and 403(b)s.
Required minimum distributions (RMDs)
First of all, for 2020, it waives seniors’ yearly requirement to withdraw money from their retirement accounts in the amount defined by their age, IRS rules and calculating tables. They can choose to withdraw nothing for tax year 2020. Beneficiaries of inherited IRAs also enjoy the waivers.
Initially, it was unclear what would happen to those people who took their RMDs early in the year (before the CARES Act passed). A ruling came out on June 23, 2020 (IRS Notice 2020-51), giving everybody until Aug. 31, 2020, to roll the amount of the RMD taken back into their qualified account.
Coronavirus-related distributions (CRDs)
In 2020, Corona-related distributions are allowed from eligible retirement accounts to qualified individuals.
Withdrawals: If you have been affected by the virus, the CARES Act lets you withdraw up to $100,000 of your vested balance from a qualified IRA or retirement account without being subject to the under-59-1/2-early-withdrawal penalty of 10 percent.
To help with your tax burden, you can choose to spread the income from these CRDs evenly over three years.
Any time in those three years, you also have the option of replacing or “recontributing” any portion of the CRD that might be eligible for a tax-free rollover back into an eligible retirement account. So, if finances improve, you have a way to put the money back into an eligible account and avoid the taxes on the recontributed portion.
Loans: Again, if the virus has affected you, CARES says you can borrow up to 100 percent of your vested account balance or $100,000, whichever is less, from a qualified employer retirement plan. (Traditionally, the limit is the lower of 50 percent of vested balances or $50,000.) The details can depend on your employer’s plan.
Keep in mind, loans are not allowed for IRAs.
It is a misconception that everyone is eligible for a CRD; there are eligibility requirements that must be met.
While this is not the most comforting answer, you are expected to “self-certify” that you meet the eligibility requirements. Generalized public discomfort led the IRS to clarify its initial definition of who would be considered a “qualified individual” by issuing IRS Notice 2020-50 on June 19, 2020. It says the people who are eligible include:
- IRA owners and plan participants (or their spouses or dependents) diagnosed with the coronavirus by a CDC-approved test, or
- Account holders who have experienced certain adverse financial consequences because of the Corona pandemic.
IRS Notice 2020-50 states that the financial setbacks affecting the account holder, spouse or household member could come from:
- A quarantine, furlough, layoff, or reduced work hours,
- An inability to work due to lack of childcare,
- Owning a business forced to close or reduce hours,
- Reduced pay or self-employment income, or
- A rescinded job offer or delayed start date for a job.
The amount you withdraw doesn’t have to match the amount of your financial need, and it can be taken in multiple distributions, as long as they stay below the $100,000 limit.
What are the pros and cons?
What any financial advisor will suggest is that you think carefully about if and how much you withdraw. You should consider all the pros and cons. Do you take a loan or make a withdrawal? Will you lose out on market improvements while your money is out of your IRA? Should you take the tax hit all at once or over three years? How will your retirement planning be affected in the long run? And, don’t forget state taxes will be owed?
Whatever your answers, given the impact on personal finances of the shutdowns, layoffs and market fluctuations, you may not have much choice but to withdraw funds. The key is to do so in a way that has the least possible negative impact on your long-term finances.
Is the reporting requirement complicated?
You will have to report any CRDs on your federal income tax return and Form 8915-E (Qualified 2020 Disaster Retirement Plan Distributions and Repayments). You’ll use the same form to report any funds you recontribute to qualified retirement accounts.
You can recontribute at any point during the three years following the date of the CRD. If you decide to recontribute funds after you have paid taxes on the reported CRD income, you’ll have to file an amended return, plus the Form 8915-E, to get your refund.
The CARES Act offers you several ways to help bridge the tumultuous – and uncertain – time brought on by the coronavirus. The goal is to make the most of the benefits it offers you in a way that serves your needs the best.