Retirement Funds – Penalty-Free Distributions and Loans

The CARES Act (“the Act”) has provided taxpayers affected by COVID-19 with some relief in the area of retirement plan distributions and loans.

What is the definition of those affected by COVID-19? Affected taxpayers include any individual:

  • who is diagnosed with the virus SARS-CoV-2 or with coronavirus disease COVID-19 (by a CDC approved test);
  • whose spouse or dependent is diagnosed with the virus or disease; or
  • who experiences adverse financial consequences as a result of quarantine, furlough, layoff, reduced work hours, the inability to work due to lack of child care because of the virus or disease, or the closure or reduced hours of a business that is owned or operated by the individual due to the virus or disease.

For these affected taxpayers, the following provisions of the Act allow individuals to use retirement funds, otherwise not accessible, to help supplement income during this difficult time.

Retirement plan distributions

A coronavirus-related distribution of up to $100,000 from an “eligible retirement plan” made no later than December 31, 2020, is permitted without being subject to the 10% early withdrawal penalty. The limit applies in aggregate to all plans maintained by the employer or a controlled group. The taxpayer may treat the distribution amount as subject to tax ratably over the three taxable periods beginning with the year of distribution. Repayment of the distribution back to the qualified plan is allowed during the three years following the date of distribution, without regard to the yearly cap on retirement plan contributions.

An “eligible retirement plan” is defined as the type of plan that is eligible to accept tax-free rollovers. It includes 401(k) plans, 403(b) plans, governmental 457 plans, and IRAs (including SEP-IRAs and SIMPLE-IRAs). It does not include nongovernmental 457 (b) plans.

Retirement plan loans

The Act increases the limit on loans from qualified plans to $100,000 (from the previous amount of $50,000). A taxpayer may take a loan from a qualified plan up to the lesser of $100,000 or 100% of the account balance. The increased loan limit is effective for 180 days following the Act’s enactment date. The due date of the outstanding loan balance occurring during the period beginning with the enactment date and ending on December 31, 2020, is delayed for one year, without the accrual of interest. For loans that were incurred before March 27, 2020, repayments required during the period of March 27, 2020 and December 31, 2020 may also be delayed for up to one year without penalty, however, interest will accrue on those earlier loan balances. The delay period is not considered when applying the five-year maximum repayment term applicable to plan loans.

Employer plans may need to be amended to allow for the above hardship provisions. For plans to remain qualified, plan amendments must be made no later than the last day of the plan year that begins on or after January 1, 2022 (December 31, 2022 would be the final date to make plan amendments for a calendar year plan). Governmental plans are provided an additional two year window.

BNN Observations: Please note that the loan provisions apply only to qualified plans such as 401(k), 403(b), and governmental 457 plans; loans may not be taken from IRAs. However, it is possible for a taxpayer to achieve the same result here from an IRA by utilizing the distribution provision from an IRA but returning the contribution to the IRA within the allowed three year window.

Taxpayers are advised to thoroughly consider the long term implications of taking advantage of these hardship withdrawal provisions. Obviously, if under dire circumstances, it’s useful to have these options available. But consider that with a severely reduced market value, loss of future tax-deferred earnings and growth, and loss of principal for withdrawals, available retirement funds will be severely reduced when retirement time actually comes about.

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Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.

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