On March 27, President Trump signed into law a $2 trillion stimulus package (the CARES Act) that will help individuals and businesses devastated by the coronavirus.
Here are some of the CARES Act 401(k) and IRA implications:
Early 401(k) and IRA Withdrawals
The bill allows affected individuals under the age of 59 ½ to take withdrawals from their qualified retirement plans (401k, IRA, etc.) without incurring the Sect 72(t) penalty of 10%, up to $100,000. However, the exception only applies to:
- An individual who is diagnosed with SRS-COV-2 or COVID-19 by a test approved by the CDC,
- whose spouse or dependent is diagnosed with one of the two diseases, or
- who experiences adverse financial consequences as a result of being quarantined, furloughed or laid off or having work hours reduced, or being unable to work due to lack of child care.
While the distribution is exempt from 10% penalty, it doesn’t escape income tax. The Act, however, allows the taxpayer to spread the income over a 3-year period beginning in 2020. The taxpayer can also avoid any income recognition by repaying the distribution to the retirement plan within three years of receiving it.
While this may seem like a good idea initially, we would not recommend this as your first option. You may avoid the 10% penalty, but you still owe taxes. We suggest taking advantage of any stock market losses you have incurred in your taxable investment accounts. The strategy you can employ is called tax loss harvesting.
Tax Loss Harvesting
Tax loss harvesting is the practice of selling a security that has experienced a loss and by realizing, or "harvesting" a loss, investors are able to offset taxes on both gains and income. Depending on how much cash you need, you will want to coordinate the sale of your investments with your overall asset allocation strategy.
Another option to consider before withdrawing money out of your 401k is a 401k loan, if your plan allows it. If it doesn’t, the legislation allows for plans to adopt it immediately. With a 401(k) loan, you won’t owe income tax on the amount you borrow, assuming you pay back the loan within five years. Note, you will have to pay back the funds with after-tax dollars.
Moreover, if you leave or lose your job, you may be required to pay back the balance early. If you are unable to pay it back you you will owe taxes and possibly an early-withdrawal penalty. You also have to pay interest on the loan, but are effectively paying the interest to yourself.
With all these options it can be difficult to determine the best option to generate short term cash needs. Our financial advisors and tax professionals at Glass Jacobson are here to help you make the best decision for you and your family.
Waiving Required Minimum Distributions for 2020
Typically, you are required to take your RMD by April 1 of the year that you turn 70 ½ and by the end of each subsequent year. The recently passed Secure Act extended the age to 72 but if you turned 70 ½ last year you are still required to take your 2020 RMD.
Under the CARES Act, you have the option not to take your 2020 RMD. This could be a much-needed relief for investors as markets may be slow to recover from the steep decline in recent weeks. RMDs are calculated based on Dec 31 values of the previous year which in 2019 put the DOW around 28,000. You would be calculating an RMD based on values that have disappeared in recent weeks resulting in a very large distribution.
If you have any other questions about any CARES Act 401(k) or IRA implications, please contact us!
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