August 05, 2020

            Individuals with retirement assets may have new options due to the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”). Under these new rules, certain investors may access their retirement savings with a coronavirus related distribution (CRD) and plan loans. Furthermore, the CARES Act suspends required minimum distributions (RMD) and allows any RMDs to be paid back.

            Estate planners and investors may integrate these rules with historically-low interest rates to move wealth in a tax-efficient manner. For example, under the current rules, an investor may now take a CRD and a plan loan totaling $200,000 of liquidity. The investor may then make alternative investments, lend the funds to their beneficiaries with a low interest rate loan, make taxable gifts, or otherwise use those funds to achieve their goals.

            This article briefly discusses three critical changes to the taxation of retirement assets and how qualifying investors may benefit from the new rules.  

Individuals affected by COVID-19 may now withdraw up to $100,000 early without penalty.

            Typically, an additional tax of 10% is applied to early withdrawal from a qualified retirement account.¹ Section 2202 of the CARES Act, however, eliminates this early withdrawal penalty for “coronavirus related distributions” up to $100,000.²  Therefore, now, a qualifying individual may take $100,000 out of their account penalty free if they are under the age of 59 and ½ so long as they meet the qualifications for a CRD. A CRD is a distribution from a qualified retirement account to an individual who satisfies one of the following conditions:

• Has been diagnosed with COVID-19,
• Their spouse has been diagnosed with COVID-19,
• Has experienced adverse financial consequences from been furloughed,  quarantined, laid off, had work hours cut,
• Has been unable to work due to lack of child care, or
• Has closed or reduced hours of a business they own or operate.

            In June, the IRS released Notice 2020-50 expanding the definition of a CRD. Notably the guidance expanded the scope of CRDs to individuals whose spouses have been adversely affected by COVID-19 or its related lockdowns, quarantines, and economic consequences. Under Notice 2020-50, a much larger group of people now qualify to take a CRD.  These additional categories extend to individuals who:

• Had a reduction in pay or self-employment income due to COVID-19 or had a job offer rescinded or start date for a job delayed due to COVID-19;
• Have a spouse or member of the individual’s household³ being quarantined, furloughed, or laid off, or had work hours reduced, or was unable to work due to lack of child care, or had a job offer rescinded or start date delayed due to COVID-19; or
• Had a reduction of hours of a business owned or operated by their spouse or by an individual in their household due to COVID-19.

           Any income recognized by a CRD may be spread out over a three year period beginning with the taxable year of the distribution.⁴ For example, if an investor withdraws $90,000 as a CRD and is required to recognize $18,000 of capital gain on the sale of retirement assets, then only $6,000 capital gain will be recognized year one. The remaining $12,000 will be recognized in years two and three.⁵ Regular distributions may also be CRDs thereby qualifying for three year income recognition.⁶ Deferred gain recognition further incentivizes investors to consider taking a CRD.

Furthermore, CRDs may be repaid and rolled over within three years after the CRD.⁷ Individuals must report any CRDs on their 2020 tax return and on Form 8915-E Qualified 2020 Disaster Retirement Plan Distributions and Repayments.⁸ Individuals should collect and maintain records showing how they were impacted by the COVID-19 pandemic to prove they are qualified to take a coronavirus related distribution.

Plan loans for up to $100,000

            Another way to access retirement liquidity under the CARES Act is through plan loans. The CARES act allows certain individuals to take out loans up to $100,000 or 100% of their vested account balance from a qualified employer plan.⁹ Previously, plan participants were only allowed to borrow up to $50,000 or 50% of their vested account balance.¹⁰ Qualified individuals with outstanding loans shall defer loan repayment by one year if the loan is to be repaid before December 31, 2020.¹¹ All further repayments are to be adjusted to account for the delayed repayment.¹² The guidance contains a safe harbor for obtaining delayed repayments under section 2202(b).¹³ Generally speaking, plan participants with outstanding plan loans should consult their advisors to see if they qualify for delayed repayment.

            Taken together, the CRD rule and the plan loan rules create a possibility where an individual may access up to $200,000 of liquidity from their retirement assets in 2020 with minimal tax consequences. This could be a powerful tool for achieving estate, business succession, and wealth management goals. Anyone considering liquidating retirement assets should do so only after careful consideration and consultation with advisors.

Required minimum distributions are now waived for many retirement accounts.

            Section 2203 of the CARES Act waives the requirement for RMDs from defined contribution plans including 401(k), 403(b), and Individual Retirement Accounts (IRA). The provisions waiving RMDs apply to distributions made in 2020.  Any distributions received as RMDs are eligible for rollover back into a qualified plan. Furthermore, there are no coronavirus-related eligibility rules for the waiver of RMDs.  This means that retirees may choose to suspend distributions or to reinvest distributions they have already received.

            On June 23, 2020, the IRS issued guidance on the application of the RMD waivers.¹⁴ The new guidance addresses transitional rules, a discussion of plan amendments, rollover guidelines, and a question and answer section.¹⁵ Individuals who have received RMDs in 2020 may choose to rollover those distributions back into a retirement account, and suspend future RMDs. This would be a preferable option for retirees who are interested in continued appreciation on their assets. 

Conclusion

            Investors and retirees should revisit their retirement planning objectives in light of the CARES Act and recent guidance. For investors considering alternative investments, these rules create unique financing opportunities. For older investors seeking to reinvest in the financial markets, the waiver of RMDs and RMD rollover options may be attractive. In any event, individuals should only move retirement assets after careful consideration and consultation with their advisors.

¹ I.R.C. § 72(t).

² Pub. Law 116-136 Section 2202(a)(1-2).

³ Notice 2020-50 (“For purposes of applying these additional factors, a member of the individual’s household is someone who shares the individual’s principle residence.”).

⁴ Pub. Law 116-136 Section 2202(a)(5)(A).

⁵ $6,000 will be recognized in year two. $6,000 will be recognized in year three.

⁶ Notice 2020-50.

⁷ Id.

⁸ Id.

⁹ Pub. Law 116-136 Section 2202(b)(1).

¹⁰ I.R.C. § 72(p)(2).

¹¹ For detailed information regard the specific operation of these rules see Notice 2020-50 section 5 discussing plan loans.

¹² Id.

¹³ Notice 2020-50 Section 5.

¹⁴ Notice 2020-51.

¹⁵ Id.