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Be Your Own Lender: Using retirement funds to help you through crisis Coronavirus related distributions and loans from retirement plans

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Through the CARES Act, the Federal government has given taxpayers several avenues to help them through the ongoing COVID-19 crisis. For taxpayers that have diligently saved for retirement, The CARES Act also provides an option to use retirement savings to assist with COVID-19 related expenses.

Taxpayers who experienced adverse financial difficulties due to COVID-19 now have the ability to withdraw up to $100,000 from their qualified retirement plans without the adverse consequence of the 10% early withdrawal penalty. Withdrawals between January 1, 2020 and December 31, 2020 qualify for the treatment outlined.  

Who is eligible? 

This is important. Only “qualified individuals” obtain the favorable tax treatment of retirement fund distributions. Just having a retirement account does not automatically qualify a person. To be “qualified” the person must be experiencing financial difficulties as a result of COVID-19. These include direct and indirect impacts. Direct financial difficulties include:

  • diagnosed with the virus;
  • their spouse or dependent is diagnosed;
  • financial difficulties due to:
    • being quarantined, furloughed or laid off, or work hours reduced due to COVID-19; or
    • unable to work due to lack of childcare; or
    • the business they own had reduced hours or was closed due to COVID-19.

Indirect financial difficulties can also qualify a person to use retirement funds with favorable treatment such as:

  • reduction of pay or job offer rescinded or delayed start due to the virus;
  • taxpayer’s spouse is quarantined, furloughed or laid off as well as reduced work hours, lack of childcare, reduction in pay/self-employment income, or job offer rescinded or delayed start date; or
  • spouse owns or operates a business that has reduced hours or was closed.

What are the tax benefits?  

As mentioned above one benefit is avoiding the traditional 10% penalty on early withdrawals. Another benefit is having the option to either (1) pay back the loan or (2) keep the loan amount and pay tax on it. 

For example, a qualified individual has withdrawn the full $100,000 distribution limit from her 401(k) plan (a qualified retirement plan).  The individual can pay tax on the $100,000 over three years starting with the  2020 income tax return (tax year ending December 31, 2020). Alternatively, to avoid additional tax, they could roll a distribution back into their qualified retirement account before filing of the 2020 return, including extensions.  Further, they have the ability to roll the funds at any time during the 3 year period.  To continue the example, If they pays tax for the first 2 years but roll the entire loan amount back into a qualified retirement account in year 3, then they would be able to amend the prior 2 years and receive a refund a tax previously paid.

Overall, if a client is experiencing financial difficulty and has built a retirement savings the ability to use these funds could help mitigate their circumstance. 

While we hope this article has provided valuable insight we strongly advise that you please work with your CPA to ensure you qualify for favorable tax treatment.