The CARES Act is making it easier for you to tap your retirement plan to help get through the financial crisis caused by the Coronavirus pandemic. The law allows for Coronavirus retirement plan distributions and loans. The loans aspect can be a fantastic way for small business owners to tap their retirement plan for very quick, low-cost funding to assist in business short-term cash flow needs. While the new law provides greater flexibility in using your retirement plan, an abundance of caution should be used as well.
The new law waives the 10% penalty for withdrawals if you are under age 59-1/2. The 10% penalty is waived as long as the distribution qualifies as a “Coronavirus-related Distribution”. The rules are below but it appears to be a pretty liberal interpretation. You can make a distribution of up to $100,000 in 2020 and avoid the 10% penalty. If your retirement plan is a 401k or Traditional IRA, this distribution will still be taxable. However, the taxes can be spread out over a three-year period, beginning with the 2020 tax year.
You also have the ability to repay the distributions over a three-year period beginning the day after you take the distribution, and this can be treated as a rollover which means you don’t pay tax on it. In other words, you can treat this as a loan.
A “Coronavirus-related distribution” is a distribution from a 401K or IRA, made in 2020 to you, your spouse or your dependent who is diagnosed with the Coronavirus. It also applies if you experience adverse financial consequences as a result of being quarantined, furloughed or laid off, having work hours reduced due to the Coronavirus. You are also affected if you are unable to work due to a lack of child care due to the virus, closing or reducing hours of a business owned or operated by an individual affected by the virus or other factors as the IRS may determine at a later date.
If you have your retirement plan in an employer 401(k) plan and the plan allows for loans, the CARE Act increased the amount of the loan from $50,000 to $100,000 (or 50% of your plan balance if it is less). This is only true for loans taken between March 27, 2020 and December 31, 2020. Additionally, the repayment start date can be delayed by 1 year and then you have 5 years to repay the loan.
It all sounds great, doesn’t it? Here are some pitfalls:
- The distribution is taxable, even if you can take three years to pay the tax.
- Traditionally, if you take a loan from a 401(k) and you leave that employer (voluntarily or involuntarily), the loan could be changed to a taxable distribution and you would have to pay taxes on it in the year you changed or lost your job. Unless the IRS comes out with different guidance on this, I would imagine this remains the same.
While taking Coronavirus retirement plan distributions provisions may be a great opportunity to make things easier during these tough times, taking money from your retirement plan should come as a last resort. Be sure to think it through and be prepared to either repay it or pay taxes on it over the next three years. If you are a small business owner, consider this along with other ideas to manage cash flow during these tough time.