You Can Use Your Retirement Plan for COVID-19 Relief
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Individuals experiencing financial strain due to the COVID-19 pandemic may tap into their retirement plans for financial relief.
If you have an IRA and employer sponsored plan such as a 401(k), 403(b), or Governmental 457(b) plan, you may be eligible to take distributions up to a total of $100,000 while remaining exempt from the 10% early distribution penalty (25% for SIMPLE IRAs) if you qualify for the CARES Act exemption. Along with the early distribution penalty exemption, the tax on the distribution may also be spread out ratably for a period of three years. Taxpayers also have the option to roll over the distributed funds at any time during the three-year period to preserve the tax advantaged status of the funds distributed.
You may qualify for relief if you have:
- Been diagnosed with COVID-19
- A spouse or are a dependent of someone diagnosed with COVID-19
- Experienced financial hardship as a result of COVID-19
- Being furloughed, laid off, or having reduced work hours
- Not able to work due to lack of childcare
- Business closing or forced to reduced hours
Individuals who take a distribution and want to report their distributions as exempt from the early distribution penalty must file an IRS Form 5329. The form needs to be filed with the taxpayer’s tax return to identify the amount not subject to the penalty.
Three Year Tax Spread
If an individual chooses to spread the distribution taxation, it must be spread ratably over the three-year period. For example, if a taxpayer distributes $75,000 in 2020, they can split the distribution’s taxation over a three-year period. In this example, the taxpayer would pay taxes on $25,000 of it in 2020, another $25,000 in 2021, and the final $25,000 in 2022. IRS Form 8915-E must be filed with the tax return to show how the taxpayer is spreading out the taxation. The taxpayer may seek the assistance of a tax advisor if they need help completing the form.
If the taxpayer decides to roll over the amount they’ve distributed, they may do so at any time during the three-year period. If an amount has been included as taxable income in previous years, they may still roll over the amount. They may also need to amend previous years tax returns to recoup the taxes paid in previously distributed amounts.
Although not the focus of this article, there are additional provisions in the CARES Act that increase the typical loan amounts within 401(k)s that allow loans. The typical amount is the smaller of 50% of an individual’s vested balance not to exceed $50,000. Under the CARES Act, the loan amounts taken from 401(k) plans between March 27 and September 23, 2020 are increased to the lesser of 100% of an employee’s vested balance not to exceed $100,000. Employees with existing loans may also suspend payments until the end of tax year 2020. The term of the loan may also be extended for a period of 1 year.
For more detailed information about these provisions, download the IRS Notice 2020-50 or ask your tax advisor.