The CARES Act includes provisions that impact the taxability of retirement plan distributions, as well as required minimum distributions.
Key insights
- COVID-19 distributions are available if you need to rely on your retirement savings to mitigate financial impacts of the coronavirus.
- While distributions are still taxable, they are not subject to the 10% early withdrawal penalty, and the 20% federal income tax withholding is not required.
- Required minimum distributions (RMDs) for participants and beneficiaries are waived in 2020.
Have questions about the CARES Act and how it impacts distributions and RMDs?
The Coronavirus Aid, Relief, and Economic Security (CARES) Act contains a number of provisions that provide relief measures for retirement plan sponsors and retirement plan participants. While we won’t address all of them in this article, we will highlight two of the more important provisions:
- COVID-19 distributions
- Changes to the required minimum distribution (RMD) rules COVID-19 distributions
A COVID-19 distribution could help you through a tough financial time
The COVID-19 distribution provision is available if you need to rely on your retirement savings to weather the COVID-19 storm. Please note this type of distribution is in a separate class and should not be confused with a hardship distribution.
There are specific eligibility requirements, but there are no specific validation requirements; employers are able to rely on participant self-certification to determine the eligibility for this distribution. However, the reason for the distribution should be recorded, since it will be treated differently than a common plan distribution.
For details, see our recent article, “CARES Act: Impact on Retirement Accounts and Employer Sponsored Plans.”
Tax implications
While the COVID-19 distribution is still taxable, the distribution is not subject to the 10% early withdrawal penalty (if you have not reached age 59 1/2) and the customary 20% federal income tax withholding is not required. The maximum distribution amount is $100,000 and may be taken from IRAs, 401(k) plans, 403(b) plans, and governmental 457 plans.
Though federal income tax withholding does not apply to the COVID-19 distribution, you can still request it. While the $100,000 may be distributed in multiple occurrences, it is a per-participant maximum aggregated across all plans of the employer (or group of common employers and IRAs, if applicable). You are required to keep track of the limit if the distribution is taken from multiple sources.
You also have the option to claim the income for personal tax purposes over a three-year period from the year in which the distribution is processed. All or part of the distribution can be repaid to the plan or another plan or IRA during the three-year period starting on the day after the distribution.
That said, earnings on the distribution after it is withdrawn cannot be re-contributed, and the repayment will be treated as a non-taxable rollover. A special tax form will be available for repayments of COVID-19 distributions, and repayments may be made in installments.
Please note that a plan document amendment is required to implement this feature; however, amendments have not been released by the IRS and adoption dates are not required until 2022. In the interim, plan sponsors may proceed using the CARES Act provisions.
Changes to the required minimum distribution (RMD) rules
The CARES Act has a provision that waives required minimum distributions (RMDs) from individual account retirement plans and individual retirement accounts (IRAs) for tax year 2020. Individual account retirement plans include 401(k), profit sharing, 403(b) and state-sponsored 457(b) plans.
This applies to RMDs with a required beginning date of April 1, 2020. If you took an RMD in February or March, you have until July 15 to roll the distribution over to another retirement plan or IRA to offset any taxable distribution. If you took a distribution in January, the rollover period has expired, unless the IRS provides relief.
Additionally, under current policy, if you’re a beneficiary of an RMD that was already paid before March 27, 2020, you do not have the option of rolling over your 2020 RMD into a retirement plan or IRA. Under normal circumstances, some plans require you to take all distributions from a retirement plan within five calendar years following the death of the participant. However, due to the potential adverse COVID-19 impacts on beneficiaries’ current year financial status, the year 2020 will not count in determining the five-year period.
The rationale for this measure is based upon the potential adverse impact of taking an RMD; an RMD is calculated using the balance of an individual retirement account on December 31 of the year prior to the date it must be distributed to a participant. For example, the Dow Jones Industrial Average closed at 28,538 on December 31, 2019. On March 27, 2020, the Dow closed significantly lower at 21,636.78. An RMD calculated on the December 31, 2019, value could lead to a disproportionate RMD relative to today’s account values, forcing a disproportionately large taxable distribution.
The waiver does not apply to benefits payable from defined benefit or cash balance plans, since these benefits are typically paid in the form of a lifetime annuity. There is no requirement to amend a plan document to implement this measure.
How we can help
At CLA, our team stays abreast of plan changes so that we can advise our clients accordingly. If you have questions about plan distributions or RMDs, our financial advisors can help you map out a plan that suits your specific situation. Please get in touch to learn how we can help you achieve your short- or long-term goals.
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