If you are struggling financially due to the COVID-19 epidemic, you will be happy to know Congress, as part of the CARES Act enacted on March 27, has made it easier for you to access your retirement funds during this emergency.
Normally, withdrawals from traditional IRAs and qualified plans such as 401(k)s, self-employed pension plans (SEPs), tax sheltered annuities (TSAs), etc., are taxable when withdrawn and subject to a 10% early withdrawal penalty if withdrawn before you turn age 59½.
For the rest of 2020, you will be able to tap those accounts for up to $100,000 and avoid the 10% penalty, although the distributions will still be taxable. To qualify, you, your spouse or a dependent must have been diagnosed with either SARS-CoV-2 or the COVID-19 virus or have been quarantined, lost your job, had your hours reduced or are unable to work due to lack of child care. To ease the taxes on these distributions, you can choose to have distributions taxed 1/3 in 2020, 2021 and 2022. Or, if your income is very low in 2020, it might be better to tax a distribution entirely in 2020. That is a decision that can be made when you file your 2020 tax return. You also have the option of paying the distribution back over a three-year period.
Ever since 2006, individuals age 70½ or older have been able to transfer up to $100,000 annually from their IRAs to qualified charities. These transfers are referred to as qualified charitable distributions (QCDs), and here is how this provision, if utilized, plays out on a tax return:
(1) The IRA distribution is excluded from income;
(2) The distribution counts toward the taxpayer’s required minimum distribution (RMD) for the year; and
(3) The distribution does NOT count as a charitable contribution.
At first glance, this may not appear to provide a tax benefit. However, by excluding the distribution, a taxpayer with itemized deductions lowers his or her adjusted gross income (AGI), which helps with other tax breaks (or punishments) that are pegged at AGI levels, such as for medical expenses, passive losses, and taxable Social Security income. In addition, non-itemizers essentially receive the benefit of a charitable contribution to offset the IRA distribution.
If you are suddenly in need of a substantial amount of cash, probably the last thing you should do is tap your retirement funds. They are the key to a financially comfortable retirement. The younger you are, the less likely you are to think about saving for retirement, but you certainly don’t want to end up living off of only Social Security. However, there are times when there might not be any other alternative than dipping into your 401(k), IRA or other retirement plan. In that case, you have to be concerned not only with any tax liability, but also early withdrawal penalties if the funds are withdrawn before reaching age 59 1/2 Plus, some distributions may only be partially taxable and some not taxable at all, while others are fully taxable.
Like everything in the U.S. tax code, the rules relating to pension or other retirement plan distributions are complicated and governed by a variety of provisions. This article describes these various rules so you can see how they would apply to a withdrawal you might be contemplating.
The Social Security Administration (SSA) recently announced the inflation-adjusted increase in benefits for 2019. SSA’s announcement states that Social Security beneficiaries should expect a cost-of-living increase of 2.8%. However, the same announcement says that for those who are retired at full retirement age, the maximum monthly benefit will go from $2,788 to $2,861, a 2.62% increase of $73 a month. Either 2.62% or 2.8% isn’t much in the overall scope of things, considering part of that increase goes to pay for Medicare premiums and copays for medication. Those retired with only Social Security income struggle just to survive month to month.
This should be a wakeup call for still-working individuals who are living (and spending) for the moment and have no, or minimal, retirement plans or retirement savings. It’s almost imperative that individuals include contributions into retirement savings in their budgets, in one form or another, or the inevitable golden years won’t be so golden.
Tax law permits you to take a distribution from your IRA account, and as long as you return the distribution to your IRA within 60 days, there are no tax ramifications. However, many taxpayers overlook that you are only allowed to do that once in a 12-month period, and violating this rule can have some nasty and unexpected tax ramifications.
The one-year period is measured based on the date a distribution is received. If the second distribution is received before the same date one year later, it is a disqualified rollover.