Coronavirus Covid-19 Retirement Distributions and Plan Loans
Congress has provided two avenues for using IRA and 401(k) assets to get cash during the Coronavirus Covid-19 emergency. Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, eligible individuals may be able to take coronavirus-related distributions from their IRA or 401(k) plan. They may also be able to take a coronavirus-related plan loan from their employer plan.
CARES Act retirement relief
The last thing workers and retirees should be thinking about is raiding their retirement accounts right now when their market value is shaky. However, if one has no other choice, the CARES Act provides two ways to liquidate retirement assets in a reasonably tax-friendly way.
Eligible individuals may take advantage of these temporary distribution options:
- coronavirus-related distributions from an IRA or employer 401(k), tax-sheltered annuity or government plan; and
- coronavirus-related plan loan from an employer 401(k), tax-sheltered annuity or government plan.
Coronavirus-related distributions are similar to disaster area distributions. In disaster situations, these can be a handy way to get at assets otherwise locked in an employer plan. Individuals can take up to $100,000, recognize the income over three tax years, and can recontribute some or all of the $100,000 within 3 years.
Comment: Although coronavirus-related distributions are structured the same as disaster distributions, disaster distributions do not ordinarily accompany a bear market. So there are additional considerations.
Caution. Like disaster distributions, plans are not required to allow coronavirus-related distributions. If they do make coronavirus-distributions, they must be amended to provide for coronavirus-related distributions which employers can do retroactively.
Plans and individuals who can qualify
To qualify as a “coronavirus-related distribution,” the distribution must be from an eligible retirement plan made on or after March 27, 2020, and before December 31, 2020. Eligible retirement plans include traditional and Roth IRAs as well as 401(k) plans. They also included tax-exempt employer plans, including tax- sheltered annuities and nonqualified deferred compensation plans.
Eligible individuals for coronavirus-related distributions include anyone:
- 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;
- whose spouse or dependent is diagnosed with such virus or disease by such a test, or
- who experiences “adverse financial consequences” as a result the coronavirus.
Adverse financial consequences can include consequences from any of the following:
- being quarantined;
- being furloughed or laid off or having work hours reduced due to coronavirus or disease;
- being unable to work due to lack of child care due to coronavirus or disease;
- closing or reducing hours of a business owned or operated by the individual due to coronavirus or disease; or
- other factors as determined by the Secretary of the Treasury.
Comment: These consequences are written broadly. They seem to include anyone laid off or getting reduced hours because of social distancing. It is probably the unusual retail, restaurant, or travel-related worker who would not be eligible.
Caution: The total amount of distributions cannot exceed $100,000 for any tax year. It is up to the employer to keep track of this total for its plans. However, if someone has more than one nonrelated employer or has an IRA, it is up to that person to make sure total coronavirus distributions do not exceed $100,000.
An individual who receives coronavirus-related distributions may recontribute the amounts to an eligible retirement plan within three years of receiving them. The recontributed amounts are treated as though they direct trustee-to-trustee transfer within 60 days. As a result, the original distribution is not subject to tax, and the contributions are not counted against the annual contribution limits.
Comment: The recontribution option makes coronavirus-distributions similar to a plan loan but with a shorter pay back schedule. The main difference, however, is that recontribution is optional.
The receiving plan does not have to be the plan from which the funds were withdrawn, but it must be one to which a rollover contribution of the distribution could be made. Rollover treatment is not available to the extent that the distribution is a required minimum distribution.
Advantages of coronavirus-related distributions
Here are the advantages to a Coronavirus-related distribution:
- no 10 percent early withdrawal penalty;
- income smoothing over a three-year span to keep marginal rates lower and delay tax liability;
- three-year recontribution option to restore account balance and mitigate or eliminate tax liability; and
- the money does not have to be repaid (as it does with a plan loan) providing flexibility and peace of mind for individuals who might lose their jobs.
Disadvantages of coronavirus-related distributions
There are four problems that should make coronavirus-related distributions a last resort for liquidity.
First, taking early distributions from a tax-deferred retirement plan is always a problem for anyone with a normal life expectancy who does not want to run out of money during their old age. Of course, as is the case with disaster distributions, this is an emergency. It’s not like buying a sports car.
Second, and unlike disaster distributions, this particular emergency coincides with a bear market. Normally, a bear market is a time to hold tight if you can take a long-term view.
Third, even if one plans to recontribute the distribution within three years, buying into a recovered market (one hopes) poses a challenge. Many experts advise against timing the market, but the fact is selling stock cheap today for the opportunity to buy it dear later gives most of us pause.
Fourth, even though income is spread out over three tax years, distributions are taxed at ordinary rates unless the amounts are recontributed. Liquidating nonretirement account assets (if available) taxed at capital gains rates against which one can take losses might be a better option. Taking a low-interest loan (if available) might be another option.
Coronavirus-related plan loans
Another way to quickly remove money from a retirement account is a plan loan. Employers can allow and administer plan loans from their 401(k), tax-sheltered annuity or government plan. In normal times, a plan can treat a distribution of up to the lessor of $50,000 or 50 percent of the present value of the employee’s vested benefits as a loan. The employee has five years to repay the loan.
As with plan loans associated with disaster relief, coronavirus-related plan loans have increased limits of $100,000 and 100 percent of the present value of the employee’s vested benefits. In addition, if a qualified individual has a loan payment due date after March 27, 2020, and before December 31, 2020, the due date is delayed one year.
Who qualifies for a coronavirus plan loan?
Anyone who would qualify for a coronavirus-distribution would qualify for a plan loan, provided of course that the individual’s employer amended its plan to allow it.
Plan loans and terminated employees
If the employee’s job is terminated before the loan is fully repaid, the employer may require the employee to pay the entire loan balance. If the employee fails to do so, the employer can treat the unpaid balance as a taxable distribution along with any money actually distributed.
Under normal rollover rules, an employee may roll over the entire amount treated as taxable. In this context, that would mean coming up with the loan balance in cash from a source other than the actual distributed amount. That is a tall order for the newly unemployed especially since the rollover deadline is 60 days.
The Tax Cuts and Jobs Act of 2017 softened this rule by allowing a former employee to roll over the offset loan amount any time before the due date of the employee’s tax return (including extensions) for that tax year.
Comment: With an October 15 extension, that could buy the former employee who was terminated December 31 and additional 7 ½ months over the normal 60 days, or 1 year and 7 ½ months if lucky enough to be terminated a day later on January 1.
Advantages and disadvantages of plan loans
Here are the advantages of a Coronavirus-related plan loan:
- unlike Coronavirus-related distributions, distributions treated as a plan loan are not taxed at all as long as they are paid back in a timely way (though the same can be said for Coronavirus-related distributions if they are recontributed);
- the repayment can be stretched out five years whereas Coronavirus-related distributions must be recontributed within three.
The disadvantage is that plan loans must be repaid. That is good for purposes of keeping up the account balance over time, but it means it means loans are not as flexible if cash is needed in the near future. Also, there is the nightmare scenario where an employee is terminated and is taxed on any unpaid loan balance.
Coronavirus-related distributions and plan loans offer options for individuals who need to keep cash flowing. While not ideal, they do offer a way of cashing out assets today. In a best-case scenario, the distributions are not taxable provided they are recontributed or repaid in a timely way.
By James Solheim, J.D.