The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), passed by Congress on March 27, 2020, provides financial relief quickly and directly to individuals and businesses. The relief available to individuals is wide-ranging and includes important changes in the rules relating to withdrawals from many retirement accounts, including individual retirement accounts (IRAs).
The Impact of the SECURE Act on Retirement Plan Distributions
The CARES Act is the second piece of major federal legislation impacting retirement accounts in a three-month span. On December 20, 2019, Congress brought about major changes to retirement plans by passing the Setting Every Community Up for Retirement Enhancement Act (the “SECURE Act”). Under the SECURE Act, what was known as the “stretch IRA” was substantially limited, and the date by which individuals are required to take required minimum distributions (RMDs) from their accounts was extended from 70½ to 72.
Prior to the SECURE Act, a person who inherited a deceased owner’s retirement account could stretch the IRA payments, or take them over the beneficiary’s life expectancy, as determined by an IRS table and based on the account value on December 31 of the previous year. The stretch provided tremendous tax deferral, as, for example, a beneficiary age 30 could receive the IRA funds and defer tax over a period of 53 years.
Under the SECURE Act, however, only persons known as Eligible Designated Beneficiaries (EDB’s) are able to utilize the stretch treatment. All other persons who inherit an IRA or other retirement account of an owner whose death occurs after December 31, 2019 must withdraw the account funds by the end of the tenth calendar year after the IRA owner’s death. As to account owners who fail to name a beneficiary, the funds must be withdrawn by December 31 of the year containing the fifth anniversary of the account owner’s death
There are several categories of EDBs. First, a surviving spouse may continue to roll over the retirement account to his or her own IRA. Second, a minor child of the account owner may use the life expectancy payout through the age of majority, but upon reaching the age of majority becomes subject to the 10-year rule. Third, persons who are less than 10 years younger than the account owner, such as a sibling, can use the life expectancy payout, as can disabled and chronically-ill beneficiaries.
One-Year Suspension of RMDs Under the CARES Act
The CARES Act brings about more changes to retirement plan accounts. Under the CARES Act, RMDs for all taxpayers are suspended for 2020. The suspension provides needed relief to those whose accounts have experienced sharp declines in value, and allows persons to avoid withdrawals from an account in 2020 that is determined based on its value on December 31, 2019.
The suspension is available for both account owners and beneficiaries of inherited accounts. If you have commenced taking RMDs from your retirement account, you are not required to do so in 2020, and you are not required to pay tax on the amount you would have otherwise taken. If you are the beneficiary of an inherited IRA (for example, an IRA established by your mother or father), you are not required to take an RMD in 2020 and not required to pay tax on the amount you would have otherwise taken. If you reached age 70½ in 2019, and were required to take an RMD by April 1, 2020, but did not do so, both the 2019 and 2020 RMD’s are waived. Instead of taking the RMD, you can keep the money in your retirement account and avoid paying tax on it.
In addition, persons subject to the 10-year rule do not have to take a distribution in 2020, and the 10-year payout period will not begin until 2021. Similarly, persons subject to the five-year rule can extend the withdrawal period by one year (though there is still some uncertainty as to whether the extension is available for persons subject to the five-year rule for taxpayers who died in 2020).
Rules for Individuals Who Took the Distribution in 2020
The CARES Act provides limited relief for persons who took distributions for 2020 before the passage of the legislation. If the distribution is a rollover distribution and the funds are in fact rolled over to an IRA within 60 days of the date of the distribution, no tax needs to be paid and the problem is fixed. This relief is not available, however, if the account owner took an IRA withdrawal within the 365 days preceding the 2020 distribution. In addition, this option is available only to the account owner and to the account owner’s surviving spouse, as non-spouse beneficiaries are not eligible for rollover treatment. In addition, for those eligible persons, additional relief has extended the 60-day period to allow a distribution taken between February 1, 2020 and May 16, 2020 to be rolled over by July 15, 2020.
Favorable Treatment for “Qualified Individuals”
While the suspension of RMD’s applies to all taxpayers, the CARES Act also offers expanded distribution options and favorable tax treatment for up to $100,000 of distributions from eligible retirement plans to “qualified individuals.”
There are currently five distinct categories of “qualified individuals” who can take penalty-free coronavirus-related distributions. While additional eligibility may be forthcoming from the Treasury Department, a qualified individual is any individual who (1) has been diagnosed with coronavirus by a test approved by the Centers for Disease Control and Prevention (CDC); (2) has a spouse or dependent who has been diagnosed with the coronavirus by a test approved by the CDC; (3) is experiencing adverse financial consequences as a result of being quarantined, furloughed, laid off, or working reduced hours as a result of the virus; (4) is experiencing adverse financial consequences as a result of being unable to work due to lack of child care; and/or (5) is experiencing adverse financial consequences as a result of closing or reducing the hours of a business the individual owns or operates.
The CARES Act allows these “qualified individuals,” regardless of age, to take tax-favored distributions of up to $100,000 from their IRA’s in 2020. Such distributions can be reported as income evenly over a three-year period, with no interest charged. For many individuals, reporting the full withdrawal as income in 2020 would cause the individual to be taxed in a higher tax bracket. If the individual’s 2020 income is significantly lower than usual, and is expected to be higher in 2021 and 2022 as employment conditions improve, it may be better to report the entire distribution as income in 2020.
Furthermore, qualified individuals may choose to repay the distribution to an IRA or other eligible retirement plan within three years of the distribution, and treat the withdrawal and re-contribution as a tax-free rollover. Essentially, a qualified individual can “borrow” up to $100,000 from an IRA and repay the loan anytime within three years with no interest charged and no federal income tax consequences. The money can be used to pay off debt, invest in the stock market, or cover mortgage or car payments. Upon repayment, the money can be re-contributed to the IRA from which it was withdrawn, or contributed to a new IRA, or to multiple IRA’s. Finally, qualified individuals under age 59 ½ will not be subject to the ten percent (10%) excise tax on early withdrawals, even of amounts not re-contributed during the three-year window.
In all, the CARES Act provides needed and welcome relief to many persons impacted economically by the global pandemic.