Despite all the mayhem that COVID-19 has caused, the pandemic could provide a benefit that’s helpful to you and your family. The Coronavirus Aid, Relief, and Economic Security (CARES) Act provides that an eligible IRA owner is entitled to withdraw up to $100,000 in 2020 and take up to three years to repay the funds without the imposition of federal tax.
This means that if you need cash to help you get through the financial burdens caused by the pandemic, this could be a resource and a solution.
These tax-favored withdrawals are called coronavirus-related distributions, referred to here as CRDs. CRDs have no restrictions on their use, which means the money you withdraw from your IRAs can be used to pay your monthly bills and help family members, but there are certain basics that need to be reviewed first.
If you are the owner of an IRA or IRAs, you can take a total of up to $100,000 for your personal use from one or several IRAs, and it doesn’t matter if you are under the age of 59½. Under normal circumstances you would be taxed with a 10% early withdrawal penalty, but this does not apply now because of the CARES Act. You must repay all the funds within a three-year re-contribution window that begins the day after you receive the distribution. You can make re-contributions either as a lump sum payment or through multiple re-contributions. Also, the re-contributions can be made to any of your IRAs and not necessarily to the IRA account from which the CRD originated.
In addition, if your spouse owns one IRA or more, he or she is also eligible for the same CRD opportunity, as are the beneficiaries of inherited IRAs.
A CRD may be made for any amount up to $100,000 from an eligible retirement plan if made between January 1, 2020 and before December 31, 2020 under the following conditions:
1. The IRA owner was diagnosed with COVID-19 by a test approved by the Center for Disease Control and Prevention.
2. The spouse or a dependent of the IRA owner was diagnosed as having COVID-19 by a similar test.
3. The IRA owner suffered negative financial consequences by being quarantined, furloughed, laid off, or having reduced work hours because of COVID-19.
4. COVID-19 caused the necessity of childcare, resulting in an inability to work and the subsequent onset of negative financial consequences.
5. The IRA owner owns a business that was forced to close or reduce operating hours because of COVID-19 and thereby suffered adverse financial consequences.
6. Other financial losses due to COVID-19 were suffered that are yet to be defined by future IRS guidance.
There is a potential but temporary fly-in-the-ointment that might deter you from taking advantage of this tax-free and interest-free loan, and it’s this: even though you are allowed to access $100,000 from the funds in your IRAs, and though you spread the taxable income across the three-year period of 2020, 2021, 2022, you will still incur an interim tax liability in each year the funds are not re-contributed. Ultimately, at some point in 2023, prior to the three-year window coming to a close, you’ll have to amend your returns for those three tax years and recover the taxes you paid. You will still have a zero-sum result, but having to accept temporary interim tax consequences might make this strategy unattractive.
Another item to consider is that even though the CRDs provide a tax-free loan from your IRA accounts, the tax rates for the money you are borrowing could be significantly higher in 2021 and 2022 than they currently are. After this year’s presidential election and with potential political shifts in the Senate and House of Representatives, tax rates could jump higher, especially for families in higher tax brackets. Even though you’ll eventually get your tax expenditures refunded, you should be aware that loans against your IRAs could cause unexpected cash deficiencies in the short term. Of course, if it makes the most sense, you can report all your taxable income from your CRD loans on your 2020 return before tax rates potentially increase.
Regard this tax strategy as a tool that may or may not be appropriate for your use. As always, your unique circumstances should be carefully reviewed to determine if accessing tax-free funds for a maximum three-year period is in your best interests. Consulting with your tax specialist is the best way to understand the value and applicability of this strategy for your finances.
Your tax advisor will probably inquire about your need for the immediate cash, if you are confident you can repay the CRD amount within a three-year period, and whether or not the CRD income could be sheltered with 2020 business losses, making re-contributing a choice rather than an obligation. Of course, should this loan be absorbed through business losses, the effectiveness of spending your IRA funds now, compared with the benefit of allowing them to remain protected and grow in value, must also be analyzed.
We hope this article about taking advantage of a temporary pandemic-related tax-free loan was helpful. We also offer many other strategies that can be useful and we invite you to give us a call for a discussion about your portfolio so we can consider how we might accelerate your growth and how your portfolio serves the retirement lifestyle you desire. Thank you!
Joseph M. Maas, CFA, CVA, ABAR, CM&AA, CFP®, ChFC, CLU®, MSFS, CCIM
Synergy Financial Management, LLC
13231 SE 36th Street, Suite 215
Bellevue, WA 98006
This article is for general educational purposes only. Nothing should be construed as individual tax advice. Please consult a tax advisor to see if this information is right for your situation.