APR. 20, 2020
The monumental Coronavirus Aid, Relief, and Economic Security (CARES) Act focuses most of its attention to providing economic stimulus for businesses and individuals. However, there are a few provisions that change some of the rules around retirement plans and allowing those who are currently experiencing financial hardship to access these funds. In this time of anxiety around so many things, there are a few planning ideas advisers and clients can consider in order to help manage their income and retirement plans effectively.
New disaster declaration grants early access to retirement accounts
If an individual needs access to their retirement funds, whether through a qualified plan or IRA, prior to age 59½ because of the current economic situation, then they could use the new coronavirus disaster declaration exception to avoid the ten-percent tax on premature distributions. This waiver is part of the CARES Act, which recently became law.
The ten-percent tax for distributions prior to age 59½ is waived for distributions up to $100,000 from qualified plans and IRAs for coronavirus-related purposes. However, it should be noted that this ten-percent tax is not waived for distributions taken from nonqualified annuities. Any income taxes incurred on a coronavirus-related distribution can be paid over a three-year period. The individual also has up to three years to recontribute the borrowed amount to a plan or IRA – without regard to that year’s cap on contributions. An in-service distribution from a qualified retirement plan also is permitted if it is coronavirus-related. A coronavirus-related distribution is a distribution made to an individual:
- Who is diagnosed with COVID-19;
- Whose spouse or dependent is diagnosed with COVID-19; or,
- Who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, being unable to work due to lack of child care due to COVID-19, closing or reducing hours of a business owned or operated by the individual due to COVID-19, or other factors as determined by the Treasury Secretary.
Other exceptions to the 10% on pre-59 ½ distributions
If an individual needs money and can’t qualify for one of the COVID-19 exceptions mentioned, or needs more than that exception’s limit, then the individual could use what is referred to as the “age 55 exception.” However, there are some limitations to be aware of with this exception.
For instance, the age 55 exception only applies to qualified plans – it does not apply to IRAs or nonqualified annuities, and certain criteria must be met to qualify. To utilize this exception the plan participant must have worked into the year they turned age 55 for the plan sponsor of the plan from which they will be taking a distribution. Then after separating from service, the former employee can take a withdrawal from their plan account and claim the exception to the ten-percent pre-59 ½ distribution tax (the distribution will still be taxable).
Typically, the participant claims the exception on IRS Form 5329 as most qualified plans do not report this type of distribution as a known exception. It is important to note that the participant is not able to claim the age 55 exception for distributions from plans where they separated from service prior to age 55. For public safety employees, the age to use this exception is lowered to 50. Finally, this exception is not new. It has been available for many years, but it could offer relief to some who are currently experiencing financial distress.
Required Minimum Distributions (RMDs) are waived for 2020
The CARES Act waived RMDs from qualified plans and IRAs for 2020. This waiver also includes 2019 RMDs that were required to be taken before April 1, 2020. This waiver applies to both owners and beneficiaries of qualified plans and IRAs. It does not apply to the annual life expectancy-based payments beneficiaries must take from inherited nonqualified annuities.
RMD start age increased to 72
Once RMDs must resume in 2021, another important planning rule change to be aware of is the change in the starting age for required minimum distributions (RMD) for IRA owners and most qualified plan participants from age 70½ to age 72. This change was part of the SECURE Act passed in late 2019.
The age 72 starting point for RMDs applies to those individuals who turn age 70½ in 2020 or thereafter. For owners who turned age 70½ prior to 2020 RMDs must continue as before, mindful of the 2020 RMD suspension mentioned above.
With this RMD waiver, retirees who can afford to skip their 2020 distribution can now leave that money an extra year in an individual retirement account or a defined contribution employer’s savings plan, such as a 401(k) or 403(b), to recover without incurring a penalty.