Welcome to Carr Wealth Management, LLC. Our mission is to help clients manage the uncertainties of tomorrow, and we certainly have run into uncertain times. Due to the coronavirus, our economy along with the global economy is heading into unstoppable anguish. To help avoid the current and continuing economic struggle that our economy is facing, the U.S. Government has passed a massive economic stimulus bill – “The Coronavirus Emergency Relief bill (CARES Act).” Although the bill covers many important financial issues and concerns, I am focusing on the main aspects of how the bill impacts retirement accounts and retirement planning. See Below for Summary and a few examples.
Do you qualify for “Hardship Withdrawals?
To qualify for the hardship distribution, the account owner or his or her spouse or dependent must have been diagnosed with the coronavirus or lost income due to a layoff, business closure, quarantine, reduction in hours, or inability to work due to a lack of child care.
Not everybody will contract the coronavirus, but certainly, a vast majority of Americans will be adversely impacted financially and should qualify for the hardship withdrawal.
No 10% Penalty on CoronaVirus related “hardship withdrawal”
If you’ve ever had to take money out of your retirement accounts without a qualified exception before you were 59½, you’re certainly familiar with the sting the additional 10% penalty can inflict; and that’s on top of the ordinary tax due on the distribution itself. For instance, if your marginal tax rates for federal and state tax liability are 22% and 6% respectively, you would pay a total of 38% (22% +6% + 10% penalty) on distributions taken before 59½ without a qualified exception. The stimulus bill would allow “hardship withdrawals” for those under 59½ up to $100,000 without the penalty. The withdrawal, however, would still be taxable.
Thomas, age 57, has been laid-off from his employer and is forced to withdraw funds from his 401(K) plan. He decides to withdraw $50,000 from his 401(k) plan. Normally, Thomas would have to qualify for a hardship to withdraw $50,000 from his 401(K), then he would be taxed on the withdrawal at his ordinary income tax rate plus an additional 10% penalty, which could result in an overall $20,000 tax bill (assume marginal rates of 22% Federal, 8% California, and 10% penalty = 40% x $50,000).
The stimulus bill would reduce his total tax liability to $15,000 because he would not be subject to the 10% penalty. Additionally, the $15,000 liability could be paid over the next 3 years or avoided entirely by “re-contributing” the $50K (or a portion) back into the retirement account within three-years (see next).
Withdrawals on IRA’s
The stimulus bill provides that up to $100,000 can be withdrawn from your IRA without a potential tax liability. There are two choices:
- To pay the tax on the distribution over three years, or
- To “re-contribute” the amount withdrawn back into the IRA within three years and avoid any tax liability on the original withdrawal.
Same facts for Thomas in prior example. If Thomas feels that he will be able to re-contribute the $50,000 within three years, he could avoid any tax that otherwise would have been due ($15K). If Thomas only re-contributes a portion of the withdrawal, then tax would be due on the amount not re-contributed.
** Re-contribution amounts would be separate from regular contributions (not impacted at all) to retirement plans, currently $6,000 for an IRA (or $7,000 for those 50 or older) and $19,500 for a 401(k) (or $26,000 for those 50 or older.)
Janice, age 66, is recently retired. She had a 401(K) plan with her employer that she rolled over into an IRA. She doesn’t plan on receiving her social security benefits until age 70 to maximize her benefits. She realizes that delaying her social security benefits means that she will need additional income sources to maintain her lifestyle during the next four years. She is planning to withdraw $25,000 a year from her IRA to supplement her income during the next four years while her social security benefit is increasing 8% a year. She will pay ordinary income tax on the $25,000- withdrawn each year. The stimulus bill will allow her to withdraw up to $100K this year and pay tax for the withdrawal over the next 3 years. She doesn’t plan on re-contributing the $100K to her IRA. Some points:
Disadvantages of withdrawing funds from IRA or retirement plan.
- Loss of compounded growth – probably the most important element in building asset values is compounded growth, especially tax-deferred. Achieving financial goals depends on an individual’s risk tolerance among other aspects. Reducing the amount of tax-deferred, compounded growth assets may alter your financial plan and required to revisit your goals and risk tolerance level.
- Withdrawing in a down market – don’t forget the one investment principle that has endured the test of time – buy low and sell high! Assuming the markets rebound from the current decline (they always do historically; see blog “ A Glimpse of Disciplined Investing), withdrawing funds (selling assets) in a down market eliminates the opportunity for those funds to participate in the eventual surge in security prices.
- May pay higher overall taxes - Choosing to pay taxes over three years on a current year withdrawal may not be wise if you expect your tax liability to significantly decrease in the next 3 years. In Janice’s case, she would pay tax on $100K (assume $30K) in three installments of $10K a year. However, if she stuck to her original plan of $25K a year for 4 years, she may pay lower overall tax depending on her current and future tax rates.
Advantages of Withdrawing funds from an IRA or retirement plan.
- It may be a tax-free, interest-free 3-year loan – Individuals have the option of withdrawing up to $100,000 this year and re-contributing the amount (or portion of) within three years. No tax liability will result from the 2020 withdrawal if the amounts withdrawn are put back in IRA by end of 2023.
- May pay lower overall taxes – Individuals who choose to defer the tax liability on their 2020 withdrawals over three years may pay lower overall taxes if their tax rates increase in the next three years.
- The withdrawal will not be part of taxable income in years 2 and 3 (if the 3-year tax payment is chosen or the 3-year re-contribute is chosen), which can lower other costs based on taxable income - Medicare B premiums, taxable social security benefits, deduction, and credit phaseouts due to higher taxable income.
Participants may borrow 100% of their 401(K)
The bill doubles the amount 401(k) participants who have been diagnosed with the virus or affected by economic losses can take in loans for the next six months from a retirement account to the lower of $100,000 or 100% of the account balance. (IRAs don’t permit loans.) Normally, the rule is a participant can borrow up to 50% of their 401(K) balance.
This provision creates alternate methods to pull money out of your 401(K). Because 100% of your account can be loaned, the choice of receiving tax-free loan proceeds and repaying the loan over five years or more (participant can delay repayment on existing or new loans until 2021) or re-contributing any 2020 withdrawals within 3 years.
Individuals considering withdrawing from their 401(K) plans will want to carefully consider the differences between borrowing the funds form their 41(K) plan or simply withdrawing the funds from the 401(K) and take advantage of new rules (penalty-free).
Required minimum distributions from 401(k)s and IRAs
Those who contribute to tax-deferred retirement accounts, such as traditional IRAs and 401(k)s, don’t pay income tax on the money they put into these accounts. But starting at either age 70 ½ (for those born before July 1, 1949) or at age 72 (for those born after June 30, 1949), the IRS requires them to start withdrawing a set percentage of the account balance and paying income taxes.
Account-holders can always withdraw more. But if they take less than the minimum required, they could be subject to a 50% penalty on the amount they should have withdrawn—except for 2020.
The new stimulus bill provides a one-year suspension of required distributions for those who would otherwise have been forced to base their minimum withdrawals for 2020 on their account balances as of Dec. 31, 2019, when the stock market was near record levels.
Under normal rules, a 75-year-old with a $500,000 IRA evenly split between stocks and bonds on Dec. 31 would have been required to withdraw about $22,000 this year on top of losses so far of about $49,000.
The reprieve also gives those who can afford to leave their retirement nest eggs alone a better chance of recovering losses – They’ll enjoy more dollars working for them during a probable stock-market rebound.
People who have inherited 401(k)s, IRAs, or Roth IRAs can also suspend distributions in 2020.
Required distributions don’t apply to account owners with Roth IRAs (although they do apply to people who inherit Roth accounts). In addition, those who are still working beyond the age at which required distributions normally begin may not have to take a distribution from their current employer’s retirement plan until they retire, depending on the plan’s rules.
This unprecedented stimulus package touches so many industries and contains various new rules and regulations. Getting qualified financial advice is more important than ever. Each financial decision can have an impact on investments, taxes, retirement income sources, and estate planning. Please feel free to contact us to schedule a no-charge consultation, or schedule a phone conversation due to the requirements of social distancing. Or if you have a question, please let us know and we’ll get back to you with a response as soon as possible.
CPA, CFP®, MBA