By Kristi DeRycke, Registered Assistant
The recent CARES Act does include changes to your retirement plan requirements. Let’s find out what this means for you and options that you may consider. The main points to consider include not having a required minimum distribution (RMD) in 2020, penalty-free distributions, increased limits for 401(k) and 403(b) loans, possible employer reductions in 401(k) contributions and reducing your additions.
For those of you who are retired and taking money out of your retirement plan, you are currently not required to take out an RMD of any kind this year as you have in the past. This can be a very good thing as your minimum distribution number was calculated on your balance on December 31, 2019 when the values were much higher. You would now have to take out a larger number of shares than at that point to equal the RMD amount. (1)
You can also take out a coronavirus-related distribution out of a 403(b), 401(k) and IRAs of as much as $100,000 or up to 100% of the balance whichever is the lower amount. This distribution will not have the 10% early withdrawal penalty. (1) You will be taxed on that amount. You can decide to spread the taxes over the next 3 years. You can also opt to claim the entire amount of taxes on it in this year if you expect a significantly lower income in 2020 due to the virus or other circumstances. However, if things improve and you decide to pay the amount back within 3 years you will be able to recoup the taxes paid. People who have contracted the virus, had a spouse or dependent fall ill or have experienced hardship secondary to the outbreak would qualify. Hardships for small business owners also apply. You will need to check with your retirement plan sponsor first as they determine if your circumstances qualify to take out distribution without the penalty.
Loans are an option for a qualified employer plan like a 401(k) but not individual retirement accounts (IRAs). The employee can now take a loan of up to the same $100,000 or up to 100% of balance but it must be paid within 5 years. However, if you leave your job in the next 5 years that loan is due at that time. Failing to pay it back at this time will leave you with a tax situation on that amount. (2) If you currently have a loan on your 401(k), you can extend the loan for an additional 12 months.
Which option is better for you? Neither decision should be taken lightly. If you sell 100 shares right now at the lower amount, you will receive less money than you would have if you were to sell 100 shares when the market was higher. Taking money out of a retirement account may be a necessity during this time but weigh the pros and cons. Distributions can be taken out permanently and you will pay the taxes either in 1 year or over 3 years. A distribution can be paid back in 3 years if your situation improves and you can regain the taxes back. Distributions are available on any 401(k), 403(b) and IRA. Loans are not taxed like a distribution as you plan to pay it back over 5 years. Loans are only available on a 401(k)s and other employer sponsored plans. Loans can be tricky if you are not certain you will remain with the employer over the 5 years to pay back the loan. Consider how stable your employer is in this time as well. (3)
Employers are also currently struggling with finances. There are no provisions in the CARES Act to address employers, but they never have restrictions in amending their policies on matching contributions. They may decide to reduce the amount they can contribute to employee’s retirement plans. They are required to notify their employees if this occurs.
With difficult times like this, you may have to consider reducing the amount of money you are contributing to your 401(k). Make certain that you investigate what your employer’s policy on matching currently is. We want you to be able to make an informed decision about if you need to reduce your amounts below the amount that the company provides a match. The match means that if you contribute a certain amount, the company will kick in money in addition to yours. You can easily adjust your contributions up and down on your plan’s website. If things improve later this year, you can go in and adjust accordingly. Typically changes take affect within a paycheck or two.
Still have questions? These sites provided more information in addition to those referenced: https://www.irs.gov/coronavirus and https://www.grassley.senate.gov/news/news-releases/cares-act-retirement-provisions-faq. Please don’t hesitate to reach out to us if you have questions on your individual situation. We are hear for you in this difficult time!
Greg's Take On The Topic
Kristi is absolutely correct that this is a tricky situation and one that should be approached carefully by investors. I have had several conversations with clients who are considering these options due to their circumstances. I would not encourage you to look at this as free money as you will be taxed and as Kristi discussed you will selling at a lower value than what you had in the account two months ago. Work with a professional and explore all options before settling on a distribution from your retirement plan.