The CARES Act and Your Retirement Investing
The coronavirus stimulus could mean good things for your retirement accounts.
When President Trump signed the $2 trillion coronavirus relief package into law March 27, 2020, most people’s attention was squarely on the small-business relief loans, the COVID-19 stimulus checks and how they might have their rent waived or their mortgage payment suspended.
The Coronavirus Aid, Relief and Economic Security (CARES) Act also offered a number of other benefits to Americans, especially Americans in a position to stimulate their local economies in the weeks and months to come. For example, the legislation included some very big benefits for the owners of individual retirement account (IRA) plans, including the ability to make some contributions and withdrawals that normally are prohibited or heavily penalized.
While many have accused policymakers of including these benefits as a way to sneak in loopholes for “rich investors,” the reality is that every single person who has a retirement plan needs to take a close look at how these changes might affect their retirement investing returns for the better. In some cases, these provisions might allow them to help their families through a very tough economic time as well.
“The CARES Act is an unprecedented bill that will help many Americans impacted by COVID-19
navigate economic uncertainties,” said Reneika Lightbourne, a business development specialist with Advanta IRA, a self-directed IRA custodian with more than $1 billion in assets under management.
Reneika noted the legislation contains provisions that could help individuals and families experiencing financial hardship as a result of a coronavirus diagnosis. But she emphasized the importance of consulting trusted legal and tax advisors before making any withdrawals.
“There are a ton of opportunities in this new code provision, and it is going to take everyone some time to unpack all of this,” warned Tim Berry, a self-directed IRA and 401(k) attorney with more than 20 years’ experience working with self-directed investors and their accounts. “We are all going to benefit from and hear about this legislation for years to come.”
Changes in Distributions and Loans
One of the provisions of the CARES Act that will have an immediate financial impact for IRA holders is penalty-free early distributions of up to $100,000 from retirement plans. Taxes on that distribution are due in three years, however, and are spread out over the three-year period. Berry noted that this three-year window creates an unusual and possibly beneficial scenario for investors.
“If you qualify for that early, penalty-free withdrawal and take a distribution now that normally would have cost you a 10% penalty, you could save a lot of money,” he said.
Berry cited an example of an investor who was already facing the decision of whether to withdraw money from his IRA account before the benchmark age of 59½ because doing so would allow him to purchase an investment property in his own name rather than in the self-directed retirement account, creating a significant advantage. Because the investor qualified for the penalty-free distribution, he was able to save almost $10,000 on the transaction, benefiting both his current and his future financial situation.
“Another big benefit of this law is that taxes on distributions will be automatically spread out over the next three years instead of the client having to pay taxes on a $90,000 distribution in tax year 2020,” Berry said. “That means you might effectively lower the tax bracket your distribution is taxed on, and you effectively receive a three-year loan to pay the lower taxes.”
Do You Qualify?
Remember, no one automatically receives these benefits under the CARES Act. The benefits of the CARES Act are reserved for individuals who meet certain eligibility standards. According to the CARES Act itself, distributions must be coronavirus-related in nature. This is relatively broadly defined as:
You are a taxpayer who has been diagnosed with coronavirus. You are also eligible if your spouse or dependent was diagnosed with the virus and, as a result, “suffered adversity.” Eligibility extends to individuals not formally diagnosed who suffered adversity in the form of quarantine, furlough, job termination, reduced work hours, or inability to work due to inadequate child care.
Berry said, “I’m guessing that nearly everyone could say they have had their work hours reduced due to the coronavirus. It’s a pretty broad definition in the new law.”
If you are unsure whether you are eligible or if you have a conventional retirement account that is sponsored by your employer, you may need to check with the plan sponsor. However, most sponsors say they are relying on employees to “self-certify” their eligibility.
If you plan to take a loan from your 401(k) under the CARES Act, you will need to check with your sponsor (if applicable) and take that loan before Sept. 23, 2020. Investors should note that the ability to borrow against your 401(k) is not new, but the maximum amount permitted is higher than previously allowed. Before the CARES Act, you could take out $50,000 or 50% of your account balance. The new legislation permits you to take out $100,000 or 100% of your account balance. If you are unsure whether you qualify for CARES Act-related benefits, ask your trusted legal or tax professional. Although your company plan sponsor may be able to tell you whether they are permitting account holders to implement these strategies, neither your sponsor nor your custodian can necessarily provide you with full guidance regarding your eligibility. Only a tax or legal professional familiar with IRA and 401(k) policies, laws and tax code can do that.
