CARES Act: Impact to Retirement Accounts

By now you may have heard of the Coronavirus Aid, Relief and Economic Security (“CARES”) Act, which is legislation enacted by Congress (with overwhelming support) to provide fast and direct economic assistance for American workers, families, and small businesses, and preserves jobs for American industries. While the CARES Act may apply to you in a variety of ways, one particular way may be associated with your retirement accounts and corresponding withdrawals and required minimum distribution (“RMD”).

Early Withdrawals

Section 2202 of the CARES Act creates some relief for tax-qualified plans described in Section 401(a), a tax-sheltered annuity plan (Section 403(b) plans), an eligible deferred compensation plan of a State or local government employer (Section 457(b) plans), and individual retirement accounts (IRAs). These retirement plans are referred in the CARES Act as “eligible retirement plans.”

Generally, a distribution from an eligible retirement plan before 59.5 is subject to a 10% early withdrawal tax. The CARES Act creates an exemption from the early withdrawal tax for a “coronavirus-related distribution” from a qualified retirement plan, a Section 403(b) plan, or an IRA on or after January 1, 2020 and before December 31, 2020. A coronavirus-related distribution is any distribution from the above-referenced accounts due to any of the following, broadly applicable reasons: an account owner or their spouse was diagnosed with COVID-19, an account owner experiences adverse financial consequence as a result of the pandemic due to being quarantined, laid off, furloughed, have reduced housing, childcare issues, or a number of other reasons.

In the event of a coronavirus-related distribution, the CARES Act allows for up to $100,000 of withdrawals from an IRA or 401(k) exempt from the 10% early withdrawal tax. This distribution will still be subject to normal income tax rules. Furthermore, this distribution may be spread over the next three years for income tax purposes. Although, it may make sense from a tax-planning perspective to include your distribution in whole as part of your 2020 income if you anticipate a lower income year (including a distribution during a low-income year can be strategic decision to ensure less taxable income now and later).

Required Minimum Distributions

Your RMD is the minimum amount you must withdraw typically from your IRA, SEP IRA, SIMPLE IRA, or retirement plan account. As a brief summary, if you reached the age of 70.5 in 2019, you must take your first RMD by April 1, 2020 (this is under the old rule). If you reach 70.5 in 2020 or later you must take your first RMD by April 1 of the year you reach 72 (this is the new rule under the SECURE Act). Your RMD is calculated by dividing the prior year’s December 31 balance of your retirement account by the Uniform Lifetime Table, published by the IRS. This is important because if your 2020 RMD is calculated using the 2019 end-of-year balance, then the RMD will be higher due to higher balances at the end of 2019.

Section of 2203 of the CARES Act provides that no RMD is required for 2020 from qualified retirement plans (401(k) plans, IRAs, 403(b) plans, and 457(b) plans). Therefore, if you must take an RMD for 2019 by April 1, 2020 and have not yet done so, then such RMD can be waived until 2021. Further, this is not a type of deferral whereby a taxpayer is required to double their RMD in 2021 for the amounts waived in 2020. This, of course, does not impact those individuals whose first year of RMDs would be after 2020. Further, those individuals who need to withdraw money in 2020 may still do so, they just are not required to do so.

The current market is volatile and the economy is uncertain, thus causing a decline in retirement account values during the start of the year. Without the enactment of this provision under the CARES Act, given that RMDs are calculated using the prior year’s end-of-year retirement account balance and the fact that balances were high at the end of 2019, each individual’s RMD would be higher in 2020, while accounts were lower. Therefore, it is greatly beneficial for most individuals to leave their retirement accounts untouched for 2020 to the extent financially feasible. For those that do not need their RMD, now is a good time to suspend their RMDs for 2020.

Interestingly, if an individual takes their RMD in 2020, which such distribution can be done as early as January, then the CARES Act does not offer relief; there is no relief for those that took an early distribution. In such event, all is not lost though, as there are certain strategies that your accountant or financial advisor can assist you with implementing. Such strategy includes rolling over your RMD from an IRA or 401(k) to an IRA within 60 days to avoid such distribution being treated as a taxable distribution.

While the above-discussed provisions related to the early withdrawals are not directly tied to or applicable to these RMD rules, they could assist those individuals who took an RMD in January, or prior to enactment of these rules, by allowing them to potentially treat the distribution as a coronavirus-related distribution and repay it over the next three years, or in 2020.

For individuals who die and whose interests are not fully distributed in certain retirement accounts without designated beneficiaries, under the Internal Revenue Code the remaining portion of such account must be distributed within five years of the account owner’s death. The CARES Act creates flexibility for these accounts and allows for a one-year deferral. The non-designated beneficiaries inheriting those retirement accounts are given an additional year if the five-year period includes 2020. For example, for an account with respect to an individual who died in 2018, the five-year period will end in 2024 instead of 2023. The five-year rule is expanded to be the six-year rule.

The extension of the five-year rule under the CARES Act is not to be confused with being an extension of the ten-year distribution rule under the SECURE Act. With regards to RMDs, the SECURE Act replaced the lifetime stretch provisions for designated beneficiaries of certain retirement accounts with a ten-year distribution rule. This rule requires that the designated beneficiaries of such accounts distribute/withdraw the full account within ten years, beginning the year after the year of death of the account owner. This portion of the SECURE Act does not extend the ten years to an eleventh year.

During these difficult times, it might be unreasonable to expect all affected people to understand a lengthy and detailed piece of legislation that is continuously being updated. The key goal with the CARES Act is to provide relief to the American people during the current pandemic. To assist you in understanding how the provisions might assist you during this time, do not hesitate to reach out to your attorney, accountant, or an advisor, each of which can provide you with helpful guidance on how to place you in a more secure place financially.

If you have tax law questions and need legal assistance, please contact Buckley Law at 503-620-8900.