The COVID-19 pandemic has upended just about everything this
year, including retirement planning. Enough new rules governing Individual
Retirement Accounts and workplace 401(k) plans were introduced that a year-end
review is in order.
Congress enacted many of these regulations with the aim of
making it easier for people to tap into their accounts, if necessary, to stay
afloat financially. Some of these rules apply to 2020 only. Others will last
longer. Some provisions already have expired.
Here's a recap of four relevant planning tips and whether
you might be able to take advantage of them down the road.
Easing withdrawal penalties
Background: Workers participating in 401(k)-style
plans and investors in traditional Individual Retirement Accounts have long faced
a deterrent to pulling out money early — a 10% penalty that applies generally
on withdrawals taken prior to age 59 ½. (Roth IRA investors don’t face this
penalty on money that represents contributions — it can be pulled out penalty
free at any time — and earnings typically grow tax free, too.)
COVID-19 change: Congress made retirement funds more
accessible by waiving the 10% penalty and by not requiring tax withholding
(which normally applies) on up to $100,000 of withdrawals made in 2020. These
rules apply to people meeting any of several coronavirus medical or economic
hardships including diagnosis of the disease, a layoff, a reduction in work
hours, a business closure or inability to work because of difficulty in finding
child care.
In addition to the penalty waiver, anyone making such
withdrawals may treat them as having been taken over three years, to ease the
tax bite, and people have the option of rolling some or all the money back into
retirement accounts to avoid any taxes due.
These liberalized withdrawal rules are available for
401(k)-style accounts if employers adopt the changes. About half of respondent
companies now allow them, according to a recent survey from the Plan Sponsor
Council of America. Employers that have adopted the rules report that few
workers so far have pulled out money.
“Knowing that (people) could access those retirement funds
in an emergency may well have tempered actual withdrawals to date, though we’re
not out of those woods just yet,” noted Nevin Adams, head of research for the
American Retirement Association.
2020 deadline? The 10%-waiver and accompanying rules
are temporary. They can be utilized only through the unusual deadline of Dec.
30, 2020, said Ed Slott, a certified public accountant and retirement-planning
specialist at IRAhelp.com.
Greater access to 401(k) loans
Background: Workplace 401(k) plans typically allow
employees to borrow some of the money from their accounts. Loans typically are
quick and easy to set up and often can be taken out with modest interest
expenses and fees. Prior to the COVID-19 pandemic, federal rules typically
limited borrowings from a 401(k) to a maximum of $50,000 or 50% of vested
account balances.
COVID-19 change: Sensing that people would be pinched
by the pandemic and economic fallout, Congress allowed employers, if they
chose, to boost the dollar amount of loans to $100,000 (or to an employee’s
vested amount, if less than that). Similarly, the CARES Act allowed loan
repayments to be delayed up to one year.
As noted, employers had to have embraced the increased loan
amounts, and about one-third adopted the changes, according to the Plan Sponsor
Council of America survey. As with the 10% penalty waiver, you could utilize
this provision if you were directly affected by COVID-19 such as having been
diagnosed with the virus, losing work because of it and so on.
2020 deadline? The higher loan-amount rules were
temporary and expired in September. Thus, 401(k) loans are still available, but
under the lower borrowing limits as before.
Slott doesn't see this as a big problem for most people,
arguing that direct withdrawals are a better option given their expanded
flexibility — namely, the ability to spread the tax bite over three years and
ability to roll money back into an account. By contrast, he said, 401(k) loans,
if not repaid, can trigger taxes and a 10% penalty in some cases.
"Loans are a commitment" that don't make as much
sense for people who might face heightened financial uncertainty ahead, he
said.
RMDs waived, for now
Background: People owning IRAs and other
tax-deductible retirement accounts (but not Roth IRAs) usually must start
withdrawing money as an RMD, or required minimum distribution, upon reaching a
certain age. Those who don't comply face a 50% tax on what should have been
taken out but wasn't. For years, RMDs applied to investors after reaching age
70 ½, but recently 72 was adopted as the new starting age.
The money withdrawn is taxed as ordinary income, so people
who don’t require these distributions to make end meet often prefer to delay
them as long as possible.
COVID-19 change: Congress suspended the RMD
requirement for 2020. It even allowed people who made withdrawals earlier this
year to put the money back into their accounts to delay the tax bite (though
the deadline for doing that has since elapsed).
2020 deadline? RMDs were waived for 2020 only. But as
before, account owners still may make voluntarily withdrawals from IRAs or
401(k)-style accounts.
Charity transfers still allowed
Background: Several years ago, Congress decided to
allow people 70 1/2 and up to transfer up to $100,000 each year from IRAs to
favored nonprofit groups. These donations can satisfy the RMD rules listed
above. Donors wouldn’t receive a tax deduction on these gifts, known as
Qualified Charitable Distributions, but most taxpayers no longer qualify for
donation deductions anyway.
Rather, there are other tax reasons to consider making a
QCD, if you can afford to do so and want to help charities.
In particular, the amount transferred doesn't get included
as adjusted gross income. That might help you avoid paying tax on some of your
Social Security income, Slott said. It also might prove handy in lowering
premiums for Medicare Part B or D coverage and avoiding the surtax on net
investment income (for wealthier seniors). Using a Qualified Charitable
Deduction "helps get money out of IRAs at zero tax cost," Slott said.
COVID-19 change: Though they tie in with RMDs,
Qualified Charitable Deductions weren't directly affected by coronavirus-relief
efforts. They still may be used by older IRA owners who want to support nonprofits.
2020 deadline? The QCD option doesn't expire this
year.
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