Along with the massive changes in our lives (hope everyone and their family are doing ok), the recent CARE act
implemented some massive changes in the laws for retirement plans.
For the sake of simplicity I want to narrow the focus of this article to just the changes regarding retirement plan distributions and retirement plan loans.
In the past, if you took a distribution out of your retirement plan, and you were under the age of 59.5 you had to pay an early withdrawal penalty of 10%. This was in addition to the ordinary income tax you would owe on the distribution as well.
Example: I'm 29 years old (A fella can dream can't they?). I take a distribution of $45,000 from my IRA. Not only do I pay my regular taxes on the distribution but I have to pay a penalty of $4,500. Ouch!That was the past.
Under the new rules, you are allowed to take out up to $100,000 without the 10% early withdrawal penalty. The only catch is that the distribution needs to be coronavirus-related
. What is coronavirus related? It's a pretty broad definition in the new law:
(i) on or after the date of the enactment of this Act and before December 31, 2020,
(ii) to an individual—
(I) who is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention,
(II) whose spouse or dependent (as defined in section 152 of the Internal Revenue Code of 1986) is diagnosed with such virus or disease by such a test, or
(III) who experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off or having work hours reduced due to such virus or disease, being unable to work due to lack of child care due to such virus or disease, closing or reducing hours of a business owned or operated by the individual due to such virus or disease, or other factors as determined by the Secretary of the Treasury (or the Secretary's delegate).
I'm guessing that pretty much everyone could say they have had their work hours reduced due to the virus. If that's the case everyone is eligible to say that their distribution is coronavirus-related.
Example: I just got off the phone today with someone who was buying a $90,000 condo in their 401k. They wanted to purchase it in their name so they could benefit from the depreciation but they were under 59.5 and didn't want to have to pay the 10% penalty on a distribution from their 401k. They are now taking a distribution of the cash from the 401k and closing on the property in their personal name. This change in the law saved them $9,000!
Another big benefit of the law is that taxes on distributions will be automatically spread out over the next 3 years. So for the above example, instead of the client having to pay taxes on a $90,000 distribution in tax year 2020, they will pay taxes on $30,000 in 2020, $30,000 in 2021, $30,000 in 2022. Not only might this lower the tax bracket the distribution is taxed on, but you effectively receive a 3 year loan to pay the lower taxes as well.
Think of this in the context of you using the distribution to purchase something that you can front load the depreciation deductions on. This could be something you could use a cost segregation study on, 100% depreciation or the 179 deduction. In year one you get a 100K deduction, yet you get to drag out the tax liability on the distribution for 3 years.
But wait, there's more.
Once you take your coronavirus-related distribution, you have up to 3 years to change your mind. Following up on the above example. Clients took a distribution of $90,000 on April 15, 2020. They have up until 3 years to put the money back. This really could be the ultimate Roth conversion. You take a distribution, you use the money personally for a while. Then you put it back into your retirement plan. Who knows you might even move it to a Roth.
It doesn't stop here either. There are a couple of additional benefits for those of you fortunate enough to have self directed 401ks.
The first is that there is no 20% withholding on the coronavirus-related distribution. Back in the olden days of pre-2020, if you asked for a $100,000 distribution from your 401k, the trustee had to withhold 20% or $20,000 to pay over to the IRS immediately. That meant the net amount to you was only $80,000.
With the new law, there is no withholding with coronavirus-related distributions up to $100,000. If you want a $100,000 distribution you get the full $100,000. No loss of $20,000!
Yet another big change is the plan loan provisions. In the past the max you could borrow out of the plan was the lesser of 50% of your account balance or $50,000. Under this new law you can now borrow out the lesser of $100,000 or 100% of your account balance. If you combine this with the 3 year payback provisions mentioned earlier, you can effectively take out $200K as a loan from your plan.
Quite honestly there are a ton of planning opportunities in this new code provision and it is going to take some time to unpack all of this. I'm sure we are all going to benefit from, and hear about this legislation for years to come.