Important Updates: CARES Act Retirement Account Changes
The CARES Act includes two important provisions related to retirement accounts: a suspension of required minimum distributions and a new exception to the early withdrawal penalty.
Changes to Required Distributions
Normally, taxpayers are required to take a distribution from their retirement plans when they turn 72 (70 ½ for tax years before 2020). The CARES Act eliminates the required minimum distribution (RMD) rules for 2020, so taxpayers may skip taking their RMD for this year. In addition, account owners may skip the 2019 RMD if it was the taxpayer’s first RMD and has not been taken yet.
For taxpayers who already withdrew their 2020 RMD, there is a limited window to recontribute the funds and treat the distribution as a nontaxable rollover. The funds must be recontributed within 60 days from the distribution in order to exclude it from taxable income in 2020. This rollover window may be expanded to 3 years if the distribution meets one of the tests for coronavirus-related distributions (see below). The distribution will be fully taxable in 2020 if more than 60 days have lapsed and the distribution is not considered a coronavirus-related distribution.
UPDATE (6/25/2020) – The IRS issued new guidance for taxpayers who already withdrew their 2020 RMD. Taxpayers can now repay a distribution that would have been an RMD had the CARES Act not eliminated the RMD requirement for 2020. The repayment must be made by August 31, 2020. Note that this change only applies to distributions that would have been treated as an RMD had the law not been changed; it does not apply to other distributions in excess of the RMD requirement.
If a taxpayer takes a distribution from a retirement account before they turn 59 ½, the distribution is subject to a 10% early withdrawal penalty unless an exception applies. The CARES Act added an additional exception to the penalty: coronavirus-related distributions. The 10% early withdrawal penalty will not apply for coronavirus-related distributions of up to $100,000. The distributions must be made during 2020 to qualify for this exception.
The taxpayer must meet one of three tests for the distribution to be considered a coronavirus-related distribution:
- Taxpayer has been diagnosed with COVID-19 by a test approved by the CDC,
- Taxpayer’s spouse or dependent has been diagnosed with COVID-19 by a test approved by the CDC, or
- Taxpayer has experienced adverse financial consequences as a result of being quarantined, being furloughed or laid off, having work hours reduced, or being unable to work due to child care issues related to COVID-19. For business owners, this test is met if their business has been closed or reduced hours due to COVID-19.
A coronavirus-related distribution may be made from the following retirement accounts:
- Individual retirement accounts, including traditional IRAs, SEP IRAs, and SIMPLE IRAs
- Defined contribution retirement plans including 401(k) plans, pensions, and profit-sharing plans
- Qualified annuities or annuity contracts
- Governmental eligible deferred compensation plans (i.e. a governmental §457 plan)
UPDATE (6/25/2020) – The IRS issued new guidance to expand the definition of coronavirus-related distributions. In addition to the tests noted above, a taxpayer may take a coronavirus-related distribution if they experienced adverse financial consequences as a result of:
- Taxpayer 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;
- The taxpayer’s spouse or member of the individual’s household (i.e. someone who share’s the taxpayer’s principal residence) was quarantined, furloughed, laid off, had work hours reduced was unable to work due to lack of childcare, had a reduction in pay or self-employment income, or had a job offer rescinded or start date for a job delayed due to COVID-19; or
- A business owned or operated by the taxpayer’s spouse or member of the taxpayer’s household closed or reduced hours due to COVID-19.
The CARES Act also allows taxpayers to defer income from coronavirus-related distributions. Rather than reporting the entire distribution as income during 2020, the taxpayer can spread the income evenly over a 3-year period beginning with 2020. Alternatively, the taxpayer may elect to recognize 100% of the income in 2020.
Any individual who receives a coronavirus-related distribution may instead recontribute the funds to an eligible retirement account within three years of the distribution. The original distribution is not subject to tax if the funds are recontributed. There is no guidance yet on how to report the income tax effect of a recontribution.
Contact your Copeland Buhl representative if you have questions on the CARES Act changes to retirement accounts.