Don’t Miss These CARES Law Retirement Benefits


SEnacted on March 27, 2020, Congress created the CARES (Coronavirus Aid, Relief and Economic Security) law to provide financial assistance to Americans suffering from the economic fallout from Covid-19.

Several of the most high-profile retirement provisions in the CARES Act have expired, including stimulus checks, additional weekly unemployment benefits, and the suspension of federal student loan payments. But there are still a few important benefits of the CARES Act that you can enjoy before the end of 2020.

Covid-19 early retirement account withdrawals

The CARES Act eliminates the 10% withdrawal penalty for qualified retirement account holders who have valid financial hardship related to Covid-19. It allows them to withdraw up to $ 100,000 from their tax-deferred retirement accounts, or taxable income in a Roth account, in 2020.

Under normal circumstances, withdrawing funds from most tax-deferred retirement accounts – such as a 401 (k) or traditional IRA – before age 59 and a half triggers a 10% penalty from the IRS in plus any income tax you would normally have owed on the Withdrawal. Income, but not contributions, withdrawn from a Roth account is also affected by the penalty.

Valid difficulties related to Covid-19 include a positive diagnosis of coronavirus for the account owner, their spouse or a dependent; dismissal, leave, reduced hours, incapacity for work or lack of childcare due to Covid-19; a delayed or canceled job offer due to Covid-19; or closed or reduced hours related to Covid for a business owned by the account holder or his or her spouse.

The CARES Act also removed the mandatory 20% withholding tax requirement for early withdrawals from tax-advantaged retirement accounts at the workplace. This withholding is how the IRS normally ensures that plan members pay the necessary taxes on their early withdrawals.

But just because you can avoid both the early withdrawal penalty and the withholding tax does not mean that your early distribution is tax-exempt. Michele Cagan, a Baltimore-based Certified Public Accountant (CPA), warns plan members to remember the tax bite. “The lowest tax bracket under current tax law is 10%, so you should be prepared to pay at least 10% of what you buy. So if you need to withdraw $ 50,000, expect to owe at least $ 5,000 in taxes.

The CARES law allows a certain flexibility in the payment of these taxes. Cagan notes that “you have the option of paying your taxes in three equal installments for the 2020, 2021 and 2022 tax years.”

Here is what it might look like. According to Vanguard, the median withdrawal linked to the coronavirus was $ 12,000. A hypothetical participant could choose to add the entire $ 12,000 withdrawal to their 2020 income to pay taxes all at once, or to increase their 2020, 2021, and 2022 income by $ 4,000 each year, by spreading the tax burden over three years.

That said, if your income has dropped significantly in 2020 and you can afford to pay applicable taxes this year, you could save money for years to come.

The CARES Act also allows participants to re-deposit money within three years of distribution, which is much longer than the usual 60-day allowance for re-depositing early withdrawals. If you choose to return the money, you will not owe any taxes, although you may need to file an amended tax return to recover the taxes you paid on the advance distribution before you re-file it.

The pitfalls of early disbursements

While expanded access to retirement funds can be an important financial lifeline, Cagan suggests participants try to exhaust other options first. “Even with all of these CARES law disruptions, making early withdrawals could end up costing you thousands of dollars and putting you in an even worse financial situation than you already find yourself in,” she says.

This is because the money withdrawn from your retirement investments cannot grow. “You lose the momentum on your investment, which makes it harder to recover your account,” Cagan explains. “And although you need the money now, you take it at 75 or 80, and it will be all the more difficult to get the money you need once you get to that age.”

These pitfalls may explain why only 4.5% of Vanguard Plan participants decided to take a coronavirus-related distribution as of October 30, 2020.

Loans for difficulties related to the coronavirus 401 (k)

In addition to early withdrawals without penalty, the CARES Act has also extended hardship loans from employer-sponsored retirement accounts, such as 401 (k), 403 (B) and 457, through September 22, 2020.

Under the CARES Act, plan members were allowed to borrow up to 100% of the vested balance or $ 100,000, whichever is less. This was double the normal hardship loan limits – 50% of the acquired balance or $ 50,000, whichever is less.

The window to borrow the expanded amount from a workplace retirement account is already closed, so anyone considering a hardship loan will now be limited to the maximum of 50% or $ 50,000, or a withdrawal for difficulties related to the coronavirus up to $ 100,000.

A difficult loan provision remains in effect until December 31, 2020: If you took out a difficult loan before the Covid-19 pandemic and you have a repayment due between March 27 and December 31, 2020, your repayment may be delayed for up to one year. This is because the CARES Act allows retirement account borrowers (including new borrowers) to forgo repayment in 2020. Under normal circumstances, you must repay your loan within five years and start repaying it immediately.

According to Vanguard, only 1.0% of plan members took advantage of the coronavirus hardship retirement account loan options. This may be partly because participation in the loan program was optional, so not all workplaces allowed participants to take out loans. But the downsides of 401 (k) loans may also have put people off.

The pitfalls of a 401 (k) loan

According to Kevin Matthews II, creator of Building Bread, a financial education company, “People think a 401 (k) loan is okay because you pay it off. But taking money out of the market means you’re losing the compounding factor, and you won’t see the true opportunity cost until years later.

Given the major market rebound since May of this year, Matthews is concerned that participants who took out 401 (k) loans in the spring when the market plummeted may have hurt their account’s future growth. “Borrowers won’t see the same rebound as those who stayed invested,” says Matthews. The S&P 500, for example, is up 64% from its low from March to mid-December 2020.

Additionally, job stability is a concern for 401 (k) loans. Although participants are no longer subject to the old rule requiring repayment of such a loan within 60 days of termination of employment, you will still have to repay it when your federal income tax return is due for that year. with extensions, otherwise you will have to treat the loan as a distribution and owe taxes on it.

For 2020, this means that if you take out a loan this year and lose your job, you will have to pay off the loan in full by October 15, 2021. For this reason, if your job is unsecured, a 401 (k) loan could. be a risky proposition and constitute a significant financial burden.

Should you withdraw money from a retirement account?

As financial experts implore struggling Americans to find other places to look for extra cash, like 0% APR credit cards or low-interest personal loans, Cagan concedes that “if you have to take it because there is no other choice, so take it. “

But don’t go all out just because you can. Cagan recommends that you take only what you need and no more. “But consider including the amount you will need to pay taxes so you don’t end up in trouble at tax time. For example, if you need $ 30,000, plan to withdraw $ 34,000 and pay your tax bill with the excess.

And to avoid such a dilemma in the future, Matthews gives some advice: “Everyone should have three different tax brackets to invest: a tax-deferred retirement account, a Roth retirement account, and taxable investments. Then if you’re strapped for cash, you can withdraw money from taxable investments without worrying about the implications on your tax-deferred retirement accounts, ”he says. A Roth, with his contributions without penalty and already taxed, could then be your next line of defense.

The CARES law and the RMD

Another important provision of the CARES Act was the 2020 suspension of the minimum required distributions (RMDs) or mandatory minimum withdrawals that the IRS requires for most retirement accounts. This was done to give retirement accounts a chance to bounce back from the market downturn in the first half of 2020.

Until August 31, 2020, anyone who has already taken an RMD for 2020 and wished to return it could do so without penalty. If you have not yet returned your RMD for 2020, the window has closed.

The IRS normally requires RMD withdrawals from retirement accounts belonging to people over the age of 70 and a half (for those born before July 1, 1949) or 72 (for those born after July 1, 1949) as well. only non-conjugal heirs who have inherited the tax. deferred accounts. RMDs are calculated annually on the basis of the account balance as at December 31 of the previous year.

Charitable donations under the CARES Act

In addition to reducing your taxable income by avoiding RMD this year, you may also be able to reduce your income through charitable donations in 2020.

The CARES Act allows taxpayers who do not itemize their deductions to deduct up to $ 300 for a cash contribution made to qualifying organizations in 2020. Under normal rules, you cannot deduct charitable donations unless they are itemize your deductions. Additionally, if you itemize your deductions, CARES has temporarily suspended the limits on charitable contributions for the 2020 tax year. Normally, you are limited to deductions of up to 60% of your income. This year, you can deduct 100% of your adjusted gross income.

“For the first time ever, you can reduce your tax liability to zero. Donate 100% of your AGI to charity, owe no taxes, ”says Cagan.

The bottom line

With the rapid end of 2020, there are only a few weeks left for the provisions of the CARES Act that can help you access needed funds or reduce your tax burden. However, even if you are short on time, be sure to think carefully about your financial options before deciding to take advantage of any of these temporary rules.

Consider speaking with a financial advisor or tax professional for help with this decision. You don’t want to start 2021 with regrets because you made the hasty decision to miss the deadline.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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