Cash Flow Problems? The IRS Just Changed Retirement Account Distribution -- Again

Ryan Guina

The CARES Act included provisions that gave individuals who were impacted by the COVID-19 outbreak more flexibility with taking loans or distributions from their retirement accounts, including the Thrift Savings Plan (TSP). The IRS recently expanded these rules, giving more people access to their retirement account money without paying early withdrawal penalties. Withdrawals can be repaid over three years without having to pay taxes on that money.

IRS Notice 2020-50 expands eligibility to those who have experienced “adverse financial consequences” due to the Coronavirus outbreak.

Previously, the IRS stated that eligibility was limited to an individual, spouse or dependent who had contracted COVID-19, were laid-off or had hours reduced, were unable to work due to a lack of childcare or who had to reduce hours or close their business.

The new rules expand it to include individuals who have had a job offer rescinded or a job start date pushed back, as well as spouses who are still working, but whose spouse or dependent would otherwise qualify.

What the New Retirement Account Rules Cover

No Required Minimum Distributions (RMDs) for 2020. The IRS requires retirees age 72 and older to take a minimum distribution from their Traditional retirement account each year. Traditional retirement account contributions are made prior to taxes being assessed, so the RMDs are one way the IRS ensures they receive taxes in a timely manner. The RMD requirement has been suspended for 2020, and individuals who have already made an RMD are permitted to “undo” the RMD by rolling it over to another retirement account before August 31, 2020.

Extension of Rollover Time Limit. The IRS typically requires retirement account rollovers to be made within 60 days. Failing to do so will result in the IRS classifying the transaction as a distribution that will subject the funds to taxes and an Early Withdrawal Penalty if the individual is under age 59½.

However, the CARES Act extended the 60-day rollover period for distributions taken between February 1, 2020, and May 15, 2020. Individuals will have until July 15, 2020, to contribute those funds to another retirement account without paying any taxes or penalties.

Elimination of the Early Withdrawal Penalty. To encourage individuals to invest, the IRS offers taxpayers incentives to save for retirement in the form of valuable tax benefits. On the flip side, they also encourage you to leave your money in your retirement account by requiring those who are under age 59½ to pay a 10% Early Withdrawal Penalty for taking distributions.

The CARES Act waives the 10% Early Withdrawal Penalty for those under age 59½ for distributions up to $100,000.

Investors are still required to pay taxes on the amount withdrawn, however, they can choose to pay the taxes over a three year period, decreasing the impact of the withdrawal and giving them more money for immediate needs.

Finally, investors may also repay the full amount of the distribution within three years into their retirement account (or another one if not permitted to be made into the account from which they took the distribution). This can be done as a rollover contribution.

Repaying the amount of the distribution means they would no longer owe taxes on the amount of money they withdrew. Investors would need to file an amended tax return to have the IRS refund the taxes the investor paid on the distribution.

Expansion of Retirement Account Loan Limits. The IRS previously allowed individuals to borrow the lesser of up to 50% of their 401k or TSP balance, or up to $50,000. The new law allows individuals to borrow up to $100,000.

Early Retirement Account Withdrawals Should be the Last Resort

The traditional financial advice is to avoid taking money out early from your retirement accounts at all costs. But the COVID-19 outbreak has caused an immense amount of financial difficulty and you may not be left with another alternative.

If you decide to take an early withdrawal, make sure you only take out the amount you need, and that you do it with a plan.

Finally, consider taking a distribution as opposed to a loan. Distributions require you to pay taxes on the amount withdrawn, which can be stretched out over three years. You also have three years to repay the amount and have the taxes credited back to you.

Retirement account loans do not require you to pay taxes. However, you will have large monthly payments at a time when you may not be able to afford another monthly payment. If you default on your retirement account loan, the outstanding amount will be converted to a distribution. However, you would not have the benefit of stretching out the taxes over three years, nor will you be able to repay that amount of three years. Additionally, if you lose your job, the loan becomes due in full by the tax deadline the following year. In other words, taking a distribution comes with less risk.

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