- The $2 trillion CARES Act loosened restrictions on withdrawals from individual retirement accounts.
- The act waives the 10% penalty on early withdrawals of up to $100,000 by people affected by coronavirus.
- Investors over age 72 can also halt required minimum distributions through 2020.
- You cannot borrow against your IRA holdings. You can, however, return unused withdrawn funds to avoid paying taxes on them.
I drafted a notice to my firm's clients so they can have a clear understanding of the provisions in the CARES Act, the $2 trillion economic rescue bill that President Trump signed into law last week. I wanted to share some of this information.
I am only including information about how the act actually impacts someone's individual retirement account.
Here are some key points that have been raised:
Can I take money from my IRA to cope with the economic slowdown?
The answer is yes. And what the CARES Act does is it waives the 10% early withdrawal penalty. So you are free and clear to withdraw up to $100,000 from your IRA and not be penalized.
Now, you will still owe income tax on that withdrawal, taxed at your ordinary income tax bracket. But here's the thing: This provision is for people who have been affected by the coronavirus — either you've gotten sick, or your spouse has, or one of you has lost your job or your business has been impacted. I think this would apply to pretty much everyone, to varying degrees, but be prepared to have to show this if you're using the money.
Can I put the money back to avoid having to pay income tax on funds I end up not using?
Yes! So, let's say you're in the 22% tax bracket — you'll owe 22% on the amount you've withdrawn ($22,000 on a $100,000 withdrawal) but, and this is a big but, you'll have three years to pay the taxes off.
So you can split it up equally between 2020, 2021 and 2022. Additionally, you can return cash to your IRA from this early withdrawal whenever you want over the next three years to avoid owing the taxes pro-rata.
Do 401(k) plans get the same treatment?
Sort of, but not exactly. When you take money from an IRA, you're taking your own money back, minus the taxes you owe. In order to take money from a 401(k), 403(b) or 457(b), it's either a distribution or a loan against those assets. So taxpayers with 401(k) plans have a choice.
But the CARES Act has expanded the size of the loan you can take from your 401(k) plan or similar retirement plan. Now, the borrowing limit has been raised from $50,000 to $100,000. The 10% penalty has been waived, just like for IRA owners.
If you choose to take a distribution from a 401(k), you also have three years to repay the loan to minimize what you owe in income tax , the limit is $100,000 for this, as well, matching the IRA limit.
Can I borrow from my IRA instead of taking a withdrawal?
Sorry, the answer is no. You cannot take a loan against your IRA and use those assets as collateral. This would be seen as a "non-qualified distribution" in the eyes of the IRS. Don't even attempt it.
Can I freeze my required minimum distributions if I don't want to sell stocks down 30% from their highs?
Yes. Investors over the age of 72 have been given a waiver to halt RMDs through 2020. Which means you can wait to take money out of an IRA (or other qualified plan account) until next year.
We've had clients ask us whether or not this includes beneficial IRAs that have been inherited from deceased parents. We're still waiting for definitive guidance on that, so we're telling them to hold off before taking these distributions for now. If you have already taken your RMD, you may be able to just roll that amount back into your IRA, so talk with a tax professional or financial advisor first.
If your business is hurting or you have bills coming in with no way to pay them, using an early withdrawal from your IRA is smart, provided you have a plan to return those funds to the account as soon as possible to avoid owing the taxes. This one-time waiver of the 10% penalty makes it less painful to do.
If the value of your retirement account has fallen and you do not want to sell your stocks to take RMDs, well, you got a pass this year. Hopefully things will have recovered in time for your 2021 RMD.
Once again, I urge investors to speak with a financial professional before employing any retirement account or tax strategies.