Generally withdrawing retirement account funds can be an expensive endeavor due to the taxes you have to pay on the transaction. However, a provision of the CARES Act allows tax-favored treatment for retirement account distributions in certain situations in an attempt to alleviate some of the economic hardship many Americans are experiencing as a result of COVID-19.
Waiving Penalties
IRA owners who are negatively impacted by the pandemic can take tax-favored “coronavirus-related” distributions (CVDs) of up to $100,000 from their IRAs. Those under age 59½ will have their early withdrawal penalty waived. Any eligible IRA owner can repay a CVD back into their IRA within three years of the withdrawal date and treat the withdrawal and later re-contribution as a tax-free rollover. There are no limitations on what you can use CVD funds for during that three-year period.
If the plan allows, the CARES Act also allows you to take tax-favored CVDs from your employer’s qualified retirement plan, such as a 401(k) or profit-sharing plan. The tax rules for CVDs taken from qualified plans are similar to those for CVDs taken from IRAs. A lot of details still need to be worked out about how CVDs taken from qualified plans will work, and we recommend that you contact the appropriate person with your employer for more information.
7 Rules to Follow
There are seven basic rules for taking CVDs from IRAs:
- You can take one or more CVDs up to the $100,000 limit.
- CVDs can come from different IRAs.
- The three-year re-contribution period for each CVD begins on the day after you receive it.
- You can make your re-contributions in a lump sum or through multiple payments.
- You can re-contribute to one or several IRAs, and they don’t have to be the same accounts from which you took the CVDs.
- As long as you re-contribute the entire CVD amount within the three-year window, the whole transaction or series of transactions, are treated as tax-free IRA rollovers.
- If you are under 59½, the 10% penalty tax that usually applies to early IRA withdrawals is waived for CVDs, even if you don’t re-contribute.
If your spouse owns one or more IRAs in his or her own name, he or she may be eligible for the same distribution privilege.
Are You Eligible?
CVDs can be taken from January 1, 2020 through December 30, 2020, by an eligible individual:
- Who’s diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention,
- Whose spouse or dependent (generally a qualifying child or relative who receives more than half of his or her support from you) is diagnosed with COVID-19 by such a test,
- Who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off or having work hours reduced due to COVID-19,
- Who’s unable to work because of lack of childcare due to COVID-19 and experiences adverse financial consequences as a result,
- Who owns or operates a business that has closed or has had operating hours reduced due to COVID-19 and has experienced adverse financial consequences as a result, or
- Who has experienced adverse financial consequences due to other COVID-19-related factors.
The IRS still needs to provide guidance on how to interpret the last two factors and we will do our best to provide that information as it is released.
When Paying Your Taxes Next Year…
You’ll be taxed on any CVD amount that you don’t re-contribute within the three-year window. But you won’t have to worry about owing the 10% early withdrawal penalty if you’re under 59½.
You can choose to spread the taxable amount equally over three years, starting with 2020. But here is where it gets tricky, because the three-year window won’t close until sometime in 2023. Until then, it won’t be clear that you failed to take advantage of the tax-free CVD rollover deal. So, you may have to amend a prior-year return to report some additional taxable income from the CVD. As of this writing, the IRS is expected to issue guidance to clarify this issue. Again, check in with us for the latest information.
You also have the option of simply reporting the taxable income from the CVD on your 2020 individual income tax return Form 1040. Again, you won’t owe the 10% early withdrawal penalty if you’re under 59½.
We Are Here to Help
CVDs can be a helpful, flexible tax-favored financial tool for eligible taxpayers during the pandemic. But it’s just one of several financial relief measures available under the CARES Act. We can help you take advantage of relief measures that will help you get through the COVID-19 crisis so let us know if you want any help, advice or answers to your questions.