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How Does the CARES Act Impact Retirement Investors?
The Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, was signed into law on March 27, making it the largest fiscal stimulus bill ever passed in U.S. history.
Investors should know how the act affects retirement planning considerations, specifically around distributions from individual retirement accounts and employer-sponsored retirement plans.
The bill will provide $2 trillion in aid to individuals, small businesses and entire industries disrupted by the sudden economic impact of COVID-19.
To put this tremendous amount of stimulus into context, the United States’ gross domestic product in 2019 was $21.4 trillion.
Any individual who is otherwise required to take a required minimum distribution, or RMD, in 2020 can now forgo their RMD in 2020. This relief also applies to beneficiaries of inherited retirement accounts taking only the yearly required minimum distributions.
This will provide a potentially significant tax break as investors can leave tax-deferred money in retirement plans and not pay federal or state tax on the distribution in 2020.
Given that the distribution amount is based on Dec. 31 values, before COVID-19 pandemic ravaged the world economy, the RMD amount in 2020 would have been based on a much higher retirement account balance.
If you have money directly deposited into your bank account from your IRA, consider stopping the automatic deposit unless the money is needed for cash flow. If you need the money from your IRA for cash-flow purposes, see if you can take the money from a taxable account instead.
Another potential opportunity relates to a Roth IRA conversion. Most people who are older than 70½ must take a required minimum distribution each year and pay taxes on that distribution amount. Since RMDs are suspended in 2020, an investor older than 70½ has the rare opportunity to do a Roth IRA conversion with money from their IRA that normally would go toward a required minimum distribution.
Yes, you still pay taxes, but the Roth IRA conversion would be occurring when the overall stock market is down sharply from its Dec. 31 value. The future potential growth would occur in your Roth IRA, so it would be tax-free (also, no RMD is required from Roth IRAs).
On top of that, it would further lower your future RMD amounts and the associated tax consequences.
If you already have taken your 2020 RMD, you may be able to roll the money back into your retirement plan if it is within 60 days of the distribution. If you have already done another 60-day rollover within the past 365 days, you would not be able to take advantage of the 60-day rule.
If you took your RMD very early in 2020 and have passed the 60-day window, you have another option: The rollover can be completed any time over the next three years if it can be shown that you were impacted by the COVID-19 crisis as stated by the CARES Act guidelines (see criteria below).
Typically, in-service distributions are restricted to certain hardships like death or disability. The CARES Act permits plan sponsors to allow working participants to access their 401(k) (or other employer sponsored retirement plan) if they are adversely affected by COVID-19.
Coronavirus-related distributions give you the ability to access up to $100,000 from your retirement plans if you were affected by COVID-19 in one of the following ways:
- You were diagnosed with COVID-19.
- Your spouse or dependent was diagnosed with COVID-19.
- You had adverse financial consequences as a result of being quarantined, furloughed or laid off, or had reduced work hours as a result of COVID-19.
- You were unable to work due to lack of child care availability.
- Your business hours of operation decreased.
- The IRS decides to say it is OK.
The potential tax benefits from distributions based on the above guidelines include being exempt from 10% early withdrawal penalty if you are younger than 59 1/2 and no mandatory withholding from employer-sponsored retirement plans.
Also, there is eligibility to be paid back over three years, and income may be spread equally over three years (2020, 2021, 2022).
Given the liberal criteria around accessing funds from your retirement accounts, it may make sense to withdraw money from your IRA account in 2020 with the intention of paying the taxes over a three-year period.
With all the uncertainty affecting so many parts of everyday life as a result of COVID-19, the CARES Act gives investors an opportunity to make smart planning decisions that may lower or defer tax liability.
