Expertise Beyond the Numbers

How the CARES Act Changes Retirement Plan Rules

SC&H’s Key Takeaways

  • Individuals impacted by COVID-19 have additional access to retirement account funds without penalty
  • Limitations on loans from qualified retirement plans are temporarily relaxed, allowing for additional financial flexibility
  • Required Minimum Distribution requirements are suspended for 2020
  • Planning opportunities are available for taxpayers normally subject to RMD requirements

The passing of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) made several changes to the rules governing retirement funds for qualified individuals impacted by COVID-19. In-service distributions are less restrictive, tax burdens have been eased, and certain penalties have been waived. Below, we discuss some of the key changes that may impact you.

Qualified Individuals Eligible for Relief

Most of the relief provisions of the Act only apply to “qualified individuals.” A qualified individual is someone who:

  • is diagnosed with COVID-19;
  • has a spouse or dependent diagnosed with COVID-19; or
  • experience adverse financial consequences as a result of:
    • being quarantined due to COVID-19;
    • being furloughed or laid off or having work hours reduced due to COVID-19;
    • being unable to work due to lack of childcare due to COVID-19; or
    • the closing or reduction in hours of a business owned or operated by the participant due to COVID-19.

The plan participant simply self-certifies that he meets one of the requirements. No other documentation is required.

In-Service Distributions

Plan participants who are still employed are normally restricted from taking distributions from a qualified plan (401(k), 403(b) and 457(b)). Provisions under the CARES Act now allow qualified individuals impacted by COVID-19 to take “coronavirus-related distributions” (CRD) through December 31, 2020.  The total CRD amount from all sources cannot exceed $100,000.

Qualified Employer Plan Borrowing Limits

Qualified individuals who have been impacted by COVID-19 now have additional borrowing capacity from their employer’s qualified retirement plan. Previously, borrowing limits on qualified employer plans were set at the lesser of $50,000 or 50% of the vested account balance. The CARES Act increased those limits to the lesser of $100,000 or 100% of the vested account balance. Loan payments that are due between March 27, 2020 and December 31, 2020, may be delayed by one year. Accordingly, this also extends the maximum five-year repayment period by one year. Accrued interest is delayed during this period as well.

Taxation of Coronavirus Related Distributions 

The CARES Act has eased several tax consequences for qualified individuals taking CRDs up to $100,000.

The 10% early distribution penalty is eliminated for pre-59 ½ withdrawals taken in tax year 2020. The income tax on distributions still apply, but they may be paid over a three-year period beginning with tax year 2020.

The 20% Federal income tax withholding requirement on early distributions has also been eliminated for CRDs taken in tax year 2020.

Individuals may avoid inclusion of these distributions in taxable income by repaying the CRD within three years. Alternatively, it the individual does not intend to repay the CRD, he may elect to include the distribution in taxable income ratably over a three-year period beginning with tax year 2020.

Required Minimum Distribution

The CARES Act suspended the requirement to take required minimum distributions (RMD) from defined contribution plans and IRAs for tax year 2020. This delay benefits all retirees, not just qualified individuals, by relieving them of the obligation of selling into a down market. It also reduces the income tax bill for individuals who don’t take the RMD. You can still take it if you need it, but it is not required. If you already took the RMD, you have the ability under the expanded rollover provision to put the money back into a qualified account.

It is still unclear, but this provision may also apply to inherited IRAs. For Inherited IRAs where the owner died on or before December 31, 2019, the IRA beneficiary must distribute the entire account within five years of the original owner’s death. For Inherited IRAs where the owner died after December 31, 2019, the IRA beneficiary must distribute the entire account within ten years. The CARES Act would allow beneficiaries to waive the 2020 distribution and extend the five-year and ten-year rules to six and eleven years, respectively. However, it is important to note that the Act’s language refers only to individual retirement accounts. Presumably that would also include inherited IRAs. However, further guidance is needed.

Planning Opportunities

These changes provide some needed relief for people impacted by COVID-19. They also create planning opportunities for those less impacted. If you don’t need the money, it may be a good idea not to take it. By not taking the RMD you can both reduce your 2020 tax liability and give your portfolio an opportunity to rebound when market conditions change. Additionally, foregoing your RMDs may put you in a much lower income tax bracket. If that is the case, a voluntary Roth conversion may make sense. Using this strategy, you may be able to convert some pre-tax retirement funds into a Roth IRA and pay the income tax at the lower tax rate.

For taxpayers whose income may be substantially lower in 2020 than they believe it will be in the next few years, not electing the three year income spread on a CRD might create tax savings.

If you have any questions or would to speak with one of our team members, please don’t hesitate to reach out. SC&H is here to help.