Article

CARES Act Retirement Plan Considerations for Individuals

calendar iconJune 5, 2020

The CARES Act contains a number of relief provisions that may generate additional cash flow and tax savings associated with employer retirement plans and Individual Retirement Accounts (“IRAs”).

Specifically, individuals now have more access to plan assets, tax-free or tax-deferred, via an increase in opportunities for distributions as well as the liberalization of rules for loans from employer plans.  Additionally, individuals not currently in need of cash have the ability to eliminate their minimum required distributions for 2020 or roll over these distributions, if taken in 2020. All IRA owners and plan participants should consider the long term tax and wealth accumulation benefits of a Roth conversion. Finally, all individuals should consider the importance of investment planning during these unprecedented times.

Increased Opportunities for Distributions

IRA owners and plan participants in retirement plans that are amended to accommodate the CARES Act distribution rules may take advantage of favorable tax rules for a COVID-19-related distribution. Beneficiaries can take advantage of some of these rules.

A COVID-19-related distribution is a distribution made during 2020 to someone:

  • Who is diagnosed with SARS-CoV-2 or COVID-19 by a test approved by the Centers for Disease Control and Prevention;
  • Whose spouse or dependent is so diagnosed;
  • Who experiences adverse financial consequences due to SARS-CoV-2 or COVID-19 as a result of being quarantined, furloughed, laid off, having work hours reduced or being unable to work due to a lack of child care; or
  • Who is a business owner or operator who experiences adverse financial consequences as a result of reducing that business’ hours or closing that business.

Notice 2020-50 has broadened the group of individuals who can get a COVID-19 related distribution to include individuals who experience adverse financial consequences as a result of experiencing a cut in pay or self-employment income or have a job offer rescinded or a start date delayed due to COVID-19.  In addition, an individual is a qualified individual if the individual’s spouse or someone who shares the individual’s principal residence experiences any of the foregoing.

A COVID-19-related distribution is limited to the lesser of $100,000 or 100 percent of the vested account balance, per individual, taking into account distributions from all employer plans and IRAs. A qualified individual can designate most regular retirement plan distributions as a COVID-19 related distribution, taking advantage of the tax benefits available to such distributions.

The tax benefits of a COVID-19-related distribution are numerous, including:

  • No 20-percent withholding tax on the distribution
  • No 10-percent tax for early retirement plan distributions;
  • Tax on the distribution is payable in 2020, 2021 and 2022, unless an individual elects to pay it in 2020; and,
  • If eligible for rollover, the distribution avoids tax to the extent amounts are contributed to an employer plan or a traditional IRA (but not a Roth IRA) within three years of the date of distribution.

If amounts included in income in earlier years are contributed to a plan or an IRA during the three-year period beginning on the day after the distribution is taken, amended returns may be required to claim a refund of taxes previously paid. An ordering rule applies for determining when income is not recognized as a result of the contribution of the COVID-19-related distribution. First, amounts contributed reduce income that would be recognized during the tax year or the previous tax year before that year’s tax return due date, including extensions. Additional amounts may be carried forward or back to other tax years in which amounts were or would otherwise be included in income. If adjustments are required for a tax year for which a return has been filed, amended or corrected income tax returns would be required.

Liberalization of Rules for Loans from Employer Plans

If a retirement plan is amended to accommodate the CARES Act loan rules, plan participants who have an outstanding plan loan on or after March 27, 2020, and are eligible for the COVID-19-related distribution (as described above) can suspend payments for any payment that becomes due during the March 27, 2020 to December 31, 2020 period. Payments can resume after the end of this period and the term of the loan can be extended for up to one year after the date the loan was originally due, with additional interest accruing.

In addition, the maximum loan amount for loans made on or after March 27, 2020, and before September 23, 2020, to those eligible for a COVID-19-related distribution (as described above) is increased to the lesser of $100,000 or 100 percent of the individual’s vested account balance, reduced by outstanding loans to the participant.

Revised Required Minimum Distribution Rules

The CARES Act eliminated the requirement for certain older individuals to take IRA and profit sharing plan distributions for 2020.  Some people have already taken those distributions, so Notice 2020-51 provides that these amounts can be rolled over to a retirement plan before August 31, 2020. This rollover will not be counted in applying the rule limiting IRA rollovers to one per year. Those individuals who do not annually request distributions may need to contact the IRA account holder or plan to eliminate the 2020 payment.

Employers can adopt a plan amendment to allow these required plan distributions to be waived.  If the employer does not do so, the plan participant can use the 60-day rollover provisions or the August 31, 2020 deadline to contribute the waived required minimum distribution to an IRA.

By not taking distributions in 2020 and by rolling over distributions that have been taken, individuals will accumulate more tax-deferred assets.

Conversion to Roth IRA

While retirement savings are usually provided on a pre-tax basis, in the past decades, Congress has expanded the use of post-tax retirement savings through Roth IRAs and Roth accounts in 401(k) plans.  Individuals can convert pre-tax retirement savings to a Roth account by including amounts in income. The amount recognized in income is the fair market value of the account on the conversion date. All amounts later distributed from a Roth are tax-free.

With recent market declines, many people are considering a conversion to a Roth account. By paying tax now on a depressed value of the account, future account earnings will not be taxable to the account holder or their heirs. There are no required minimum distributions until the account owner’s death, allowing the account to continue compounding earnings without annual taxes for the rest of the owner’s life.

If a plan participant can afford to pay the tax due on a Roth conversion with other funds, the benefits of conversion increase significantly as the entire account enjoys the benefits of a Roth.  In addition, amounts used to pay tax on the Roth conversion reduce the owner’s other assets that may otherwise be subject to estate and state inheritance taxes.

Importance of Investment Planning

While the market has been volatile and is down from its January high, different asset classes of the market have been affected in different ways. The market volatility has also exposed the amount of risk participants are taking, many of whom thought they were taking less risk than they were. It is important for retirement plan investments to be coordinated with personal investments. Now is the time for participants to review their risk tolerance and the risk profile of their investments, including retirement plan and personal investments.

Cherry Bekaert can review your retirement plan provisions to help you understand what cash flow and tax savings opportunities are available to plan participants and how they can be implemented.  Cherry Bekaert Wealth Management can review your investment strategy to ensure your desired returns are maximized with minimal investment risk.


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