May 12, 2020
By H. Joseph Price, Jr.
If you find yourself in need of additional funds during this pandemic, Congress has made one source more available – if you are fortunate enough to have an account balance in your retirement plan and your plan has adopted the new provisions allowed by the Coronavirus Aid, Relief, and Economic Security (CARES) Act.
When you are evaluating whether your 401(k) plan is the right place to withdraw funds or borrow from, you will want to take into account the other set of major changes to retirement plan distributions that Congress enacted just three months prior to the CARES Act.
And right off the bat, let’s mention that 401(k) plans are not the only type of defined contribution plan that have been affected by the rule changes. §403(b) plans and §457(b) plans, as well as other plans defined by IRC §401 such as profit-sharing plans, are all similarly affected. We will refer to all of these plans as “defined contribution plans” in this piece.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act came into being on December 20, 2019, and the CARES Act was enacted on March 27, 2020 as a result of the pandemic. Both of these acts contain a number of provisions that dramatically affect the rules relating to loans or distributions from defined contribution plans as well as distributions from IRAs.
The following questions and answers will attempt to bring you up to date on where things stand right now as a result of these two acts. Pay particular attention to whether the law applies to IRAs, defined contribution plans or both. In general, the laws have been relaxed to a much greater extent with defined contribution plans than with IRAs. Most significantly, no loans are allowed from IRAs.
What are the rules on taking early distributions from IRAs or defined contribution plans?
The CARES Act allows IRA owners or participants of defined contribution plans to withdraw up to $100,000 in “hardship distributions” from their account balances in 2020 without penalty regardless of the owner’s or participant’s age. A “hardship distribution” is a withdrawal made because of an immediate and heavy financial need and limited to the amount necessary to satisfy that financial need. In addition, the distributions may be repaid to the IRA or defined contribution plan within three years of the distribution unless the owner/participant elects otherwise.
What is special about those rules?
If the CARES Act did not exist, the participant would be assessed a 10% penalty along with income tax at “ordinary income” (as opposed to long-term capital gain) rates for a distribution prior to attaining age 59.5. In addition, the definition of a “hardship distribution” under the CARES Act is pretty generous. That is, it applies not only to individuals who have been diagnosed with the coronavirus but also to those individuals whose spouses or dependents have been so diagnosed. In addition, it applies to those who have experienced adverse financial consequences from being quarantined, laid off or furloughed, including having work hours reduced, or being unable to work due to a lack of child care due to the virus. It also applies to those individuals who experience adverse financial consequences as a result of closing or reducing hours of a business owned or operated by such individual due to the virus and such other factors determined by the Treasury. To date, no other factors have been provided by the Treasury.
Finally, without the CARES Act, there would be no provision that would allow you to recognize the tax on the withdrawn amount over three years.
Can you withdraw amounts from more than one plan or IRA in 2020 and still benefit from the special rules?
Yes so long as the total amount of your defined contribution plan distributions and IRA distributions do not exceed $100,000.
Is your employer required to allow hardship distributions from your defined contribution plan?
No. You are only entitled to the benefits mentioned above if your employer adopts the changes allowed by the CARES Act.
What are the rules on borrowing from your defined contribution plan?
Prior to the CARES Act, you could borrow up to the lesser of (a) $50,000 or (b) 50% of your account balance if your plan allowed it. The CARES Act changes those limits to the lesser of (a) $100,000 or (b) 100% of your account balance for loans made between March 27, 2020, and September 22, 2020.
Is your employer required to allow you to borrow from your defined contribution plan?
If your employer allows you to borrow from your defined contribution plan, must it also increase the limit on the amount that can be borrowed?
Would I recommend that you borrow from your defined contribution plan?
Yes, if you have no better alternative lending source and if you are able to pay the loan back on time. Loans from your defined contribution plan have the advantages of (1) no need to qualify for the loan if you have been adversely affected by the pandemic, (2) favorable interest rates, (3) the fact that you are paying interest to yourself and (4) speed of delivery of the funds. If there is any chance of your defaulting on the loan, then “no.”
What is the deadline for your employer to amend its defined contribution plan so that you can take advantage of the CARES act rules?
It is by the last day of the plan year ending in 2022 (last day of plan year ending in 2024 for governmental plans) provided that the plan is operated in accordance with the CARES Act provisions in the interim. As practical matter, if the plan is in the process of making early withdrawals or allowing loans at the higher limits, it should be amended to adopt the CARES Act provisions now.
By what date must you begin withdrawing funds from your IRA?
Beginning in 2020, the date is April 1 of the year after you reach 72 years old; the old law was April 1 of the year after you reached 70.5 years old. There is however a special rule that applies in 2020 (see below).
What if you attained age 70.5 in 2019? Must you take your first distribution by April 1, 2020?
No, but that is not a result of the SECURE Act which moved the “required beginning date” from (a) April 1 of the year after the year in which you reach age 70.5 to (b) April 1 of the year after the year in which you reach age 72. Rather, it is the result of the special rule for 2020 contained in the CARES Act (described below)
On what date must you begin withdrawing funds from your defined contribution plan?
This answer has two parts: If you own no more than 5% of the employer, the required beginning date is the later of (a) April 1 of the year after the year in which you attain age 72 or (b) April 1 of the year after the year you retire. How is “retirement” defined for this purpose? Strangely, it isn’t defined.
If you own more than 5% of the employer, the required beginning date is April 1 of the year after the year in which you attain age 72.
Does a special rule apply in 2020?
Yes. The CARES Act says that no one needs to take a required minimum distribution (RMD) in 2020, whether they are the owner of an IRA, a participant in a defined contribution plan or the beneficiary of a decedent’s defined contribution plan or IRA.
On what date must you begin withdrawing funds from a Roth IRA?
If you are the individual who created the Roth IRA, you do not have to take any distributions during your life ever. If you are the beneficiary of a Roth IRA that was funded by a deceased individual, you must begin taking distributions by December 31 of the year after the Roth IRA owner’s death.
What are Qualified Charitable Distributions and are they still allowed in 2020?
A qualified charitable distribution (QCD) is a distribution from an IRA directly to a charitable organization (but not to a donor-advised fund or a supporting organization). The QCD may only be made after the IRA owner or beneficiary of an Inherited IRA attains age 70.5. The QCD is limited to $100,000 per year. A QCD counts towards the RMD for the year of distribution but is not taxable to the IRA owner or beneficiary of the Inherited IRA.
QCDs are allowed to be made in 2020 although they may not be as popular as they have been in prior years because no distributions are required to be made from IRAs this year because of the “special rule” mentioned above.
This information contained in this publication is for general informational purposes only and is not intended, and should not be construed, as legal, accounting or tax advice. The author expressly disclaims all and any liability and responsibility to any person or corporation who acts or fails to act as a consequence of any reliance upon the whole or any parts of the content above