On March 27, 2020, Congress signed the Coronavirus Aid, Relief and Economic Security (CARES) Act into law to provide financial relief to Americans suffering from the economic fallout of COVID-19. The CARES Act contained tax benefits regarding early withdrawals from employee retirement accounts. These retirement benefits were not extended by the Consolidated Appropriations Act of 2021 (CAA of 2021) that took effect this week.
Typically, there is a 10% withdrawal penalty for taking distributions from a retirement account prior to age 59.5. However, the CARES Act eliminates the 10% withdrawal penalty for qualified retirement account holders who have a valid COVID-19-related financial hardship. It allows those eligible to withdraw up to $100,000 from tax-deferred retirement accounts, or taxable earnings, in a Roth account, prior to December 31, 2020. This is $100,000 in total, per person, no matter how many retirement accounts one has.
In general, section 2202 of the CARES Act provides for expanded distribution options and favorable tax treatment for up to $100,000 of coronavirus-related distributions from eligible retirement plans (certain employer retirement plans, such as section 401(k) and 403(b) plans, and IRAs) to qualified individuals, as well as special rollover rules with respect to such distributions. It also increases the limit on the amount a qualified individual may borrow from an eligible retirement plan (not including an IRA) and permits a plan sponsor to provide qualified individuals up to an additional year to repay their plan loans.
Who is defined as a “qualified individual”?
You are a qualified individual if –
- You are 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;
- Your spouse or dependent is diagnosed with SARS-CoV-2 or with COVID-19 by a test approved by the Centers for Disease Control and Prevention;
- You experience adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced due to SARS-CoV-2 or COVID-19;
- You experience adverse financial consequences as a result of being unable to work due to lack of child care due to SARS-CoV-2 or COVID-19; or
- You experience adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to SARS-CoV-2 or COVID-19.
Which retirement plans are eligible under the special rules for retirement plans and IRAs in section 2202 of the CARES Act?
Eligible retirement plans include:
- Individual retirement accounts or annuities under Sec. 408 (IRAs or SEP plans);
- 401(k) plans;
- Qualified annuity plans;
- 457(b) plans;
- Annuities purchased by Sec. 501(c)(3) organizations;
- Roth accounts (Sec. 402(c)(8)(b)) and
- (as clarified by the CAA of 2021) money purchase pension plans are included retroactively.
Loan Relief Provided Under Section 2022 of the CARES Act
Section 2202 of the CARES Act permits an additional year for repayment of loans from eligible retirement plans (not including IRAs) and also slightly relaxes limits on loans.
- Certain loan repayments may be delayed for one year: If a loan is outstanding on or after March 27, 2020, and any repayment on the loan is due from March 27, 2020 to December 31, 2020, that due date may be delayed under the plan for up to one year. Any payments after the suspension period will be adjusted to reflect the delay and any interest accruing during the delay.
- Loan limit may be increased: The CARES Act also permits employers to increase the maximum loan amount available to qualified individuals. For plan loans made to a qualified individual from March 27, 2020 to September 22, 2020, the limit may be increased up to the lesser of: (1) $100,000 (minus outstanding plan loans of the individual) or (2) the individual's vested benefit under the plan.
Employers are not required to follow the new, more permissive withdrawal and loan rules.
While section 2022 of the CARES Act provides the ability for employers to relax distribution and loan rules, it is optional for employers to adopt the more relaxed rules under this section. An employer is permitted to choose whether, and to what extent, to amend its plan to provide for coronavirus-related distributions and/or loans that satisfy provisions of section 2202. Thus, for example, an employer may choose to allow for coronavirus-related distributions but choose not to change its plan loan provisions or loan repayment schedules. Even if an employer does not treat a distribution as coronavirus-related, a qualified individual may treat a distribution that meets the requirements to be a coronavirus-related distribution as coronavirus-related on the individual's federal income tax return.
Distribution Still Taxed
Although the CARES Act eliminates the 10% penalty on early withdrawals and has waived the 20% mandatory tax withholding requirement for early withdrawals from workplace tax-advantaged retirement accounts, be aware that you will still owe taxes on coronavirus-related distributions. Early withdrawals under section 2202 of the Act will still be taxed, starting with the year in which you receive your distribution. The distributions generally are included in income ratably over a three-year period. For example, if you receive a $27,000 coronavirus-related distribution in 2020, you would report $9,000 in income on your federal income tax return for each of 2020, 2021, and 2022. However, you have the option of including the entire distribution in your income for the year of the distribution.
With the December 31, 2020 deadline drawing rapidly near, there are only a few days to take advantage of these CARES Act provisions under current legislation. However, even with such little time left, make sure to consider all financial options carefully before deciding to take advantage of these temporary rules.