The $2 trillion coronavirus-relief bill that was signed into law on Friday contains several provisions related to retirement accounts that will affect the manner in which we plan for clients.
Relaxed Required Minimum Distributions for 2020
Similar to the provision that was included in 2009 legislation, required minimum distribution from IRA’s and 401(k) accounts have been relaxed.
Prior to this legislation, those who have reached age 70 ½ (if born before July 1, 1949) or 72 (if born after June 30, 1949) and have assets in a pre-tax retirement accounts and do not meet the ‘still working exception’ are required to take out a predetermined percentage of that account annually and pay the resulting tax. There is nothing that keeps account owners from taking out more than this amount, but a failure to take out at least the required amount results in a 50% penalty of the amount that failed to be distributed. Under the proposed legislation, the required distribution rules will be relaxed for 2020. Those who still wish distribute assets and pay the resulting tax are free to do so.
IRA owners who were new to taking required distributions in 2019 and opted to delay their first withdrawal until April 1, 2020 are also relieved of having to take that distribution.
In addition, beneficiaries of inherited IRA and inherited Roth IRA accounts who would have otherwise been required to distribute a portion of those assets under IRS guidelines also have the option of not distributing anything in 2020. Those who still wish to distribute assets from these types of accounts and pay any resulting income tax (for pre-tax inherited IRA’s) may still opt to do so, but it is not required.
Increased Access to 401(k) Loans
Provisions of the current legislation will double the amount that could be borrowed from current 401(k) plans to the lesser of $100,000 or the entire account balance for those who have been diagnosed with or affected by economic losses related to the Coronavirus. This provision applies for the next six months. 401(k) loans must be paid back over 5 years, with interest to avoid tax and penalty. 401(k) loans are also due in full upon separation from one’s employer.
Those who already have 401(k) loans outstanding will be given the ability to delay any payments that are due in 2020, giving those individuals an extra year to pay back loans.
Hardship Distributions from IRA’s and 401(k)’s
Owners of IRA’s and 401(k)’s will be afforded the ability to gain access to $100,000 of hardship withdrawals from those accounts, which will be taxable. Owners who are under 59 ½ will be able to avoid the 10% early withdrawal penalty. The account owner can elect to pay the resulting tax over three years. They can also avoid the resulting tax altogether if the distribution is fully repaid to the account within three years.
In order to qualify for these hardship distributions, the account owner or his or her spouse or dependent must have been diagnosed with the coronavirus or lost income due to a layoff, business closure, quarantine, reduction in hours, or inability to work due to a lack of child care.
Roth Conversions Instead of Required Distributions
For certain situations where a retirement account owner is relieved of having to take required distributions from a pre-tax retirement account in 2020, it may make sense to consider Roth IRA conversions. This is a process whereby assets within a pre-tax retirement account are moved into a tax-free Roth IRA. This is a taxable event, but the resulting Roth IRA is afforded tax-free growth for the remainder of the accounts owner’s lifetime. This may be especially useful if assets can be converted at depressed prices and allowed to ‘recover’ within the tax-free account. This can also make sense if one’s taxable income is expected to be lower than average due to a lack of taxable required minimum distributions.
Final Thoughts
Relaxed minimum required distribution rules will provide planning flexibility for some. At the same time, having to tap into retirement accounts for loans or hardship withdrawals will have lasting implications that must be considered seriously.
As a result, we would like to encourage clients to consult with their advisor prior to taking any action, as it will be important to consider one’s specific planning needs within the context of this legislation.
All comments and suggestions are welcome.
Christopher W. Frayne, CFA, CFP®