WEALTH INSIGHTS

Dos & don’ts of retirement plan distributions under the CARES Act

The CARES Act contained provisions that allows certain individuals to take a new type of coronavirus-related distribution, and waives the 2020 Required Minimum Distributions. Jason Cain, Co-Head of the Center for Wealth Planning Excellence and Kathleen Kenealy, Director of Financial Planning, sit down to discuss what this means for you. Listen now.


Transcript

Jason: Hello, and welcome to "Boston Private Perspectives." I'm Jason Cain, the head of our Center for Wealth Planning Excellence in Boston Private. As part of our continued commitment to keeping our clients informed on current events and a perspective on how to consider a potential impact on your wealth and goals, today, I'm sitting down with Kathleen Kenealy, head of our financial planning group here at Boston Private. We're going to discuss some dos and don'ts of retirement plan distribution under the recently enacted CARES Act. Kathleen, how are you doing today?

Kathleen: I'm good, Jason. How are you doing?

Jason: I'm doing well, thanks. It's been a long road about the last several months but excited that, at least across part of the country, we're starting to open up. I wanted to chat with you today about retirement plans and the CARES Act. The CARES Act was enacted back in March as a response to COVID-19, and it had two major changes in the retirement plan provisions. Can you summarize those for us?

Kathleen: Yeah, certainly. So the biggest provisions in the CARES Act related to retirement planning considerations, the first was that required minimum distributions have been suspended for calendar year 2020. And the second is that the CARES Act included some retirement plan distribution provisions under what we're calling, the coronavirus-related distributions of the CARES Act. So I can talk about the required minimum distribution suspension for 2020 if that would be helpful because we've been getting a lot of questions about that from clients.

Jason: Yeah. To me, that's one of the biggies inside of the CARES Act. First question before we jump into it, has that happened before?

Kathleen: Yep. So back during the 2008, 2009 financial crisis, the government did suspend 2009 required minimum distributions in the Worker, Retiree, and Employer Recovery Act. So this allowed people to skip taking their RMDs in order to let their retirement account balances recover.

Jason: Got it. So, tell me when we talk about retirement account balances, what account types does this CARES Act apply to?

Kathleen: So this does include IRAs, which also includes inherited IRAs. So if you inherited an IRA from somebody else, then you can skip your required distribution for 2020. This also applies to defined contribution retirement plans, such as a 401(k) or a 403(B), but this does not apply to defined-benefit plans. And if you happen to be a procrastinator and you are supposed to take your first required minimum distribution for 2019 before April 1st, 2020, if you happen to delay, you also get to skip your required minimum distribution, effectively skipping two years of distributions this year, the one that you were supposed to take in 2019 and the one that you were supposed to take in 2020.

Jason: Fantastic. So, I'm assuming for a vast majority of the clients that we work with at Boston Private, we're talking about IRA distributions though, correct?

Kathleen: Yeah, that's correct. Yep, IRA distributions and inherited IRA distributions.

Jason: Got it. And I have a question to loop back in a moment. But I wanna get to, what was Congress and the President thinking about with regard to suspending these required distributions when they did so back in March?

Kathleen: So, predominantly, it was to allow people to let their retirement account balances recover due to the pretty significant drawdown we saw in the stock market between, sort of, mid-February and late March. You know, when you're drawing off of your IRA while the market's down to meet your required minimum distribution, it kind of has a double whammy effect of potentially selling securities while the market's down and not letting them recover, and also pulling money out of an account and paying taxes on it as well during a pretty challenging time for most people.

Jason: It's interesting because as we reflect from March 27th to here in almost mid-June, the market has made a pretty remarkable comeback. So for many folks, this is tantamount to a freebie for the year 2020, because the initial logic, at least, for the time being, who knows what the future holds, has kind of turned on its head, if you may.

Kathleen: Essentially. Although, I would say that, only about 20% of people who do take required minimum distributions, don't actually need them to live on and to meet their living expenses. So, for the remainder of people who are taking required minimum distributions, about 80% of people actually need those distributions to meet their regular living expenses. So, it's a freebie for some people, but not super helpful for others who actually do continue to take distributions in order to just continue to pay their bills.

Jason: I think that a really interesting aspect of this entire Act is that a vast majority, as you mentioned, of individuals need to take it to supplement or to provide the cash flow for living expenses. So, question, what happens if you are one of those that didn't necessarily want to take it or doesn't need to take it, and you happen to take it, you had auto distribution on January 1st of every year, you make your required minimum distribution, what happens in those instances?

Kathleen: Yeah. You do have a couple of opportunities to provide some relief there. So, one of the things that you can do is you can put your distribution back as long as you do it within 60 days of actually having taken the distribution. So, the IRS does provide 60-day rollover rule, which allows you to essentially return an IRA distribution within 60 days and not pay taxes on it. Essentially, you know, they consider it a rollover. You can almost think of it like, a short-term loan. But as long as you put back the full gross amount of the distribution, it won't be taxed within those 60 days.

They're some people that did take a distribution earlier this year or those that take monthly distributions. If you, for example, took a distribution in January, and February, and March, the 60-day rollover rule only apply to returning one distribution. So, you can return your March distribution, but not your January or February distributions as long as you do it within the 60-day window.

Jason: Got it. Now, walk me through...I've been hearing a decent amount about coronavirus-related distributions, CRD. What is a CRD, and how might that help an individual who took a distribution prior to the 27th of March, that 60-day window is now closed, but would like to put it back per se?

Kathleen: Yeah. So, the coronavirus-related distribution rules do allow you to distribute up to $100,000 from an IRA or an employer plan, has to be yours though, it cannot be from an inherited account. And it allows you to do a couple of things. And this applies for any time in 2020, so it's retroactive back to January 1st, and it will extend any distribution taken before December 31st. But in order to qualify under these coronavirus-related distributions, you have to meet a qualification of some sort, and there are both physical and fiscal qualifications. So, in order to qualify under the physical rule, you must have actually been tested and diagnosed with COVID-19. And this applies to either you, or a spouse, or a dependant. So the tricky thing here is that if you were never actually tested and diagnosed, you won't qualify under these physical impairment rules, but you may still qualify under the fiscal impairment rules.

So, if you've experienced some form of adverse financial consequences as a result of COVID-19, meaning you've either been quarantined, or furloughed, or laid off, or your work hours have been reduced, or you've been unable to work because you don't have childcare and you need to stay home, or you own a business that is closed or been operating under reduced hours, or you meet some other potential definition that the IRS or the secretary of the treasury might come out with later this year, you know, that would allow you to qualify for a coronavirus-related distribution.

So, there are a few benefits to the coronavirus-related distribution rule. So I mentioned a few minutes ago that the rules allow you to distribute up to $100,000 from an IRA or an employer plan. But there's some additional benefits for this, and I'm gonna talk about a few of these, so...

Jason: I'm gonna stop you there and ask a question. I really like the way that you differentiated between the physical and the fiscal aspects. Can you expand a little bit more on the fiscal and how it will be interpreted?

Kathleen: Sure. I mean, I think it's still a bit early to see exactly how it's going to be interpreted. These are, you know, very new rules. There's a lot going on in Congress and IRS trying to keep up with all the new rules that are coming out. I do think it's very likely that the secretary of the treasury, which has the ability to expand the definition of qualified people under these fiscal rules, they're gonna come out with some additional guidance before the end of the year broadening the group of people that this does apply to. So it's a little tough to, you know, say for certain how they're going to apply this, but I think it's gonna be very easy for a lot of people to make a case that they have been affected in some adverse way financially as a result of coronavirus. So I think that the group of people that these rules are going to apply to is gonna be quite large.

Jason: So tell me about those rules, the coronavirus-related distribution rules, what are the benefits of them?

Kathleen: Yep. So, the first benefit is that for those people who do qualify under these rules and take a distribution from an IRA or a retirement plan, those that are under age 59.5, are not subject to the 10% early withdrawal penalty that they otherwise would be subject to. Those that are over age 59.5 at the time they take a distribution from a retirement plan are not subject to the 10% early withdrawal penalty anyway. So this really does apply to anyone under the age of 59.5 taking a distribution, there's no 10% early withdrawal penalty, which is great.

The other benefit of this is that if you do take a distribution, even though the distribution is considered taxable income, you are allowed to spread that taxable income over three-year tax periods. So you would report a third of the income on your 2020 tax return, a third of the income on your 2021 tax return, and a third of the income on your 2022 tax return so that you're not getting hit with the income taxes all in one calendar year.

The other benefit is that the rules also allow you to repay this distribution over a three-year time period. So I talked a little bit before about the 60-day rollover rules, these don't apply to coronavirus-related distributions. If you do take a distribution and your financial circumstances improve, you can put the distribution essentially back in your IRA over the next three years.

Jason: Got it. So talk to me about that three-year spread, do you have to do the three-year spread? Is it optional? And when might you decide, if it is optional, to avoid it and pick it up all the income in 2020?

Kathleen: Yep. So it is optional, but it's going to default to spreading that income over a three-year period. So, if for some reason you do decide that you want to report it all in 2020, when you go to prepare your 2020 tax return, you're just going to make an election to treat all of that income as taxable income in 2020. You know, and for some people, it may make sense to put that income in one tax year. If 2020 is going to be a really low-income year for you otherwise, and you expect 2021 and 2022 to be higher income tax years for you, maybe you do want to opt-out of the default three-year spread and report that income all in this first year. You know, otherwise, maybe it does make sense to spread over three-year if you can spread it out over, you know, lower income tax brackets.

Jason: Got it. And it sounds like you really got to be on your game, have a good idea, and have done some decent amount of planning to figure out what makes the most sense. Because I could anticipate different circumstances coming up with different results.

Kathleen: Yep. Most definitely, I would say it's a really good idea to talk to your tax, prepare, and run some multiyear projections to get a good idea of what might make the most sense for your particular circumstance.

Jason: So, I've read a couple of articles about this returning the dollars to your account and the tax consequences of it. In essence, it starts to ultimately look like you might be able to borrow from your IRA. Walk me through the tax timing, because I think that's a really big component of this that people oftentimes blush over, particularly, if you're looking to pay it back in a three-year timeframe.

Kathleen: So if you do take a distribution and you elect to spread it out over three years, or even if you know in advance you plan to return the money, don't forget that even if you plan to return the distribution to your IRA, you still need to pay the taxes on it until the money is returned. So if you take the full three-year time period to fully pay back that distribution, you still have to pay the income taxes until you pay back the money. So if you, hypothetically, spread the income out over 2020, 2021, and 2022, you're still paying the income taxes spread over that three-year period. And then if you do return the funds, you will need to amend your tax return in order to see, essentially, a refund of the taxes that you paid in over that three-year time period.

So it's not quite the free lunch that I think people sort of expect this to be if they're looking at it as a short-term, you know, loan, there are dollars that are going to be tied up, you know, for income tax payments going to the government that you're not going to have in your pocket until you pay it back and amend your tax returns to get your refund.

Jason: So, you know, some people are saying that this, in essence, is creating a loan provision for IRAs but a loan provision in which you have to pay some taxes and then file refunds. Tell me, how do you feel about people accessing their IRAs to provide loans?

Kathleen: I'm generally not quite a fan of using your IRAs to provide short-term loans, I do kind of consider it, you know, funds of last resort, if you will. If you've exhausted all other opportunities, I think anything can really go wrong. You might have the best of intentions to, you know, take $100,000 out and then put it back under these rules and fully repay it, and... You know, as we've seen over the last few months, anything can happen preventing you from actually doing that. So, I do think you have to think through the logistics and all the possibilities before deciding if it's right for you. I think ultimately, this is going to be a lifeline for a lot of people that have been hurt very hard by coronavirus and the shutdowns, and this will provide some, you know, short-term relief for people that really do need it. But for that can afford not to take required minimum distributions, or can afford not to have to take a distribution out of a retirement plan under these coronavirus rules, I would say, you know, just leave your retirement accounts alone, let them continue to recover, let them continue to grow tax-deferred for as long as possible, and ultimately you'll be better off in the long run for it.

Jason: As I listen to your response, what really resonates with me is that there's a lot of stuff going on here, and to try and, you know, have a single rule or a single, "if you do this, you do this," it's much more complicated than that. If I'm a client, how do I navigate through all these issues for 2020 and beyond?

Kathleen: There's definitely a lot going on here, and everybody's situation is incredibly different, and everybody has different things going on in their lives, and different financial considerations and family considerations that they need to think through. So it's really important to talk to your advisor here at Boston Private, talk to your CPA, get on a conference call with both of them together and figure out, you know, what rules do apply to you? What are your options? What should you be looking at and considering? And come up with a plan that works for your particular circumstance, and not necessarily, you know, the one that you heard your neighbor talking about over your fence last week.

Jason: And I think that's what separates your group and the advisors at Boston Private from many other advisors, is that you love getting into all those details. And we always talk here at Boston Private about our advice-driven model, that we lead with advice and it is part of our culture. It makes us different as we are working with an advising family. So, I greatly appreciate you shedding light on these certainly unique issues that have popped up, and look forward to our next episode. So, thank you very much, Kathleen.

Kathleen: You're quite welcome. My pleasure.

Jason: But there is always uncertainty at play. I want to encourage all of our clients to reach out to their Boston Private team with any questions or concerns they might have. Providing guidance and support as your trusted advisor is our mission. You can also read our latest perspectives as the situation evolves by visiting bostonprivate.com. If you want all this information delivered right to your inbox, I encourage you to sign up for our Newsletter also on bostonprivate.com. Be sure to subscribe to the "Boston Private Perspectives" on Apple Podcast, SoundCloud, or Spotify, whatever you prefer to listen. Thank you very much.

Jason Cain is Chief Wealth Strategist, Senior Managing Director, MFO, responsible for developing and delivering comprehensive, advice-based solutions for ultra-high-net-worth clients, family offices and their professional advisors.

The views expressed in the article are those of the author and/or person interviewed and do not necessarily reflect the views of SVB Private or other members of Silicon Valley Bank Financial Group. The materials on this website are for informational purposes only, are subject to change and do not take into account your particular investment objective, financial situation or need. Since each client’s situation is unique, you should consult your financial advisor and/or tax planning professional before acting on any information provided herein