Within the nearly 900 pages of the CARES Act are a number of favorable provisions for individual taxpayers that are only available in 2020. These provisions present both opportunity and peril if they are not carefully executed. Below, we walk through the major provisions of the CARES Act related to financial planning and highlight key considerations and strategies to maximize benefit.
Tax-Favored Retirement Plan Withdrawals
The CARES Act allows eligible individuals to make up to $100,000 of coronavirus-related distributions from IRAs or employer-sponsored plans during 2020 and receive the following tax benefits:
- Exemption from the 10 percent early withdrawal penalty that would otherwise apply to individuals under age 59 1/2.
- Exemption from mandatory 20 percent federal tax withholding from employer-sponsored plans. Employer plans can rely on a participant’s self-certification that they meet the requirements of a coronavirus-related distribution.
- Repayment of amount distributed any time during the three-year period beginning on the day after the distribution was received. The repayment may be done with a single rollover, or multiple rollovers during the three-year period. If the distribution is repaid, amended returns may be filed to claim a refund of income tax attributable to the amount repaid.
- Option to include all of the income from the distribution in 2020 income, or by default it will be split evenly over three years (2020, 2021 and 2022).
Planning notes: A retirement plan account withdraw should be a last resort for emergency liquidity if all other options have been exhausted. Keep these important points in mind:
- The 10 percent penalty will not apply, yet income tax will still be owed. Make sure funds are reserved to pay income tax on hardship withdraws.
- This withdrawal may require sale of securities that are depressed in value due to the market decline. In other words, you may be selling securities at low values.
- While the withdrawal can be repaid over the next three years, those funds will be out of the market for that period of time and you may miss a potential rebound in the market. It may force you to sell low and buy high, the exact opposite of investment best practice.
- Most retirement accounts are fully protected from creditors. If bankruptcy is potentially on the horizon, you would generally not want to remove assets from your retirement plan.
Loans from Qualified Plans
The CARES Act expands limits on loans from employer-sponsored plans for eligible individuals most notably by increasing limit on loans from employer-sponsored plans to $100,000 from $50,000.
Planning notes: For all of the reasons above, taking a loan from a qualified plan should be carefully considered. Generally, a loan would be better than an outright distribution in that the loan would not incur income tax if repaid. However, a loan would still be taking assets out of the market and possibly missing out on future market gains if the market recovers. Further, the loan must still be repaid in five years to avoid being subject to income tax. Loans from qualified plans are generally not discharged in bankruptcy.
Temporary Waiver of RMD Rules for Certain Retirement Plans and Accounts
The CARES Act waived required minimum distributions for 2020 for defined contribution plans including 401(k), 401(a), 403(a), 403(b), Governmental 457(b), SEP IRA, SIMPLE IRA and Traditional IRA. This applies both to account owners and beneficiaries. This does not apply to defined benefit plans.
Planning notes: Leaving funds in your retirement account as long as possible is generally advisable for a number of reasons, especially at a time when the market is significantly down from the December 31 valuation date on which RMDs are calculated. Leaving the RMD in your account will give your account more time to recover from market lows. However, just because you can skip an RMD does not necessarily mean that you should. Your income tax bracket may be lower in 2020 than anticipated in future years and tax rates may increase in the future. If that is the case, it might make sense to do a Roth conversion with the amount that would have been your 2020 RMD (or any amount that is appropriate, you could do more or less than the RMD amount). Roth conversions are something that should also be considered in light of the SECURE Act of 2019. Additionally, with markets being lower, Roth conversions are less expensive from a tax standpoint and once assets are in a Roth IRA, the benefits of any market rebound will accrue tax free.
If you have already taken your 2020 RMD, you may be able to put it back if you do so within 60 days of the withdrawal, provided that you have not made any other indirect rollovers in the past calendar year. This option is not available to non-spousal beneficiaries of inherited IRAs who have taken already taken their 2020 RMD. As another option, you may be able to characterize the RMD as a coronavirus-related hardship withdraw and put the RMD amount back into your retirement account as you would with a hardship withdraw described above.
If you make your annual tax withholding through your RMD, you will need to make the estimated payments from other sources if you do not take a 2020 RMD.
Modification of Limitations on Charitable Contributions During 2020
The 60 percent adjusted gross income limitation on the deductibility of qualified cash contributions to publicly supported charities has been suspended for 2020. Qualified contributions do not include contributions to donor advised funds, supporting organizations and private foundations that are subject to the 30 percent limitation. The limitation rules still apply to non-cash gifts.
Planning note: Clients considering a large gift to a charity and have significant income recognition events in 2020 (for example, the sale of a business), may want to make that gift in 2020.
Before implementing any of the strategies outlined above, be sure to consult with your RKL Wealth Management advisor to determine the best course of action for your unique goals and circumstances.