What the CARES Act Means for Retirement Accounts in 2020

June 29, 2020
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The CARES Act made a few changes to the rules surrounding retirement account withdrawals...
Under normal circumstances, if you withdraw money from your qualified retirement plan – like a 401(k) or 403(b) plan – or Individual Retirement Account ("IRA") before you're 59 and a half, you will face a 10% penalty and a mandatory 20% withholding from the IRS. But until December 30, 2020, the CARES Act eliminates the 10% penalty and the mandatory withholding on up to a $100,000 withdrawal for coronavirus-related distributions ("CRD").
Of course, you'll still owe taxes on any of the pre-tax withdrawals. There's no escaping that. But instead of having to pay them all in 2020, you can spread the amount out over three years.
This might make you wonder if it's worth pulling money early from your retirement account. But first, here are a few things to consider:
First, the penalty waiving only applies to a CRD. That means you have to be experiencing financial hardship directly related to the coronavirus pandemic.
According to the IRS, you can qualify for a CRD if you fall into one of these categories:
  • You, your spouse, or a dependent is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention.
  • You experience adverse financial consequences as a result of being quarantined, furloughed or laid off, or having work hours reduced due to SARS-CoV-2 or COVID-19.
  • You experience adverse financial consequences as a result of being unable to work due to lack of childcare due to SARS-CoV-2 or COVID-19.
  • You experience adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to SARS-CoV-2 or COVID-19.
Second, if you do take a withdrawal, you're allowed to pay that amount back into your retirement account as long as you do so within three years of the withdrawal date. The means if you borrow $20,000, you can put that money back into your account without having to worry about the usual contribution limits. You can also claim a refund on the taxes you paid on the withdrawal, but you might need to amend previous tax returns.
Third, consider the purpose of your retirement account...
I advocate keeping an emergency fund of at least three months' worth of expenses. (If you're the sole provider in your family, your emergency fund should be closer to six months of expenses). If you've done that, your emergency fund is the first place you should go for money. After all, that's what it's there for.
A retirement account is meant to help you create long-term wealth generation. That's where you put money that can grow for decades. Pulling money out of your retirement account means you'll miss out on the potential for gains in the market.
But if you are experiencing financial hardship because of the pandemic and your emergency fund isn't cutting it, don't feel guilty about dipping into your retirement account.
The CARES Act also increases the 401(k) loan limit from $50,000 to $100,000, but you only have 180 days from the day the law took effect (that's March 27) to take out the loan. That means you'll have until September 23. The increase is optional for employers to offer, so check with your plan to see if it's available.
The law also has a provision for required minimum distributions ("RMDs").
Last year, Congress increased the age when you have to take your first RMD from 70 and a half to 72. (It only applied to folks not collecting yet.) The new CARES Act took that one step further... RMDs for 2020 are now suspended for everyone, regardless of age or whether or not you've already started taking your RMD.
This applies to IRAs, 401(k)s, and inherited IRAs. This doesn't apply to defined benefit accounts…
Since you calculate RMDs based on the prior year's ending account balance, that would have meant larger RMD amounts based on your balance because stocks were surging in December 2019. But those payouts mean higher income tax payments, too. This pause in collecting an RMD is a huge relief for some folks.
If you've already taken your RMD for 2020, you may be able to reverse it. But the rules around this are pretty complicated. For folks who have questions about their specific situations, I recommend contacting a tax adviser for help.