In response to the coronavirus pandemic, the federal government has taken a wide range of actions to try to limit the economic damage and help businesses and struggling families. So far, these have included several emergency moves by the Federal Reserve, passage of the $2 trillion-dollar Coronavirus Aid, Relief and Economic Security (CARES) Act, and another relief bill totaling nearly $500 billion aimed mainly at small businesses and hospitals.
The most significant of these actions for older Americans is the CARES Act, which includes several changes to retirement planning laws and guidelines. The goal is to provide opportunities for retirees and near retirees to limit potential damage to their personal finances from the coronavirus crisis, and to modernize their retirement strategy for the new “corona-economy” taking shape.
Could some of these opportunities make sense for you? For example, does the CARES Act mean you should rethink your strategy around required minimum distributions (RMDs), Social Security, or charitable giving? Does taking money from your IRA make sense now, depending on your situation? These are all questions best addressed with the help of the right financial advisor, but here are a few important points that might help you start thinking about the answers.
Does the CARES Act Mean You Should Rethink Your Strategy Around RMDs?
As you probably already know by now, the CARES Act includes a provision that suspends RMDs for 2020. But just what does that mean? Well, remember that the CARES Act is a relief bill, and by suspending 2020 RMDs, the government is giving up short-term tax revenue to provide relief to retirees. The other rationale is that with all the market volatility created by the pandemic, suspending RMDs gives many Americans the ability to leave their investment portfolios alone to recover over the next year.
Unfortunately, there are some flaws with that rationale. First, simply be aware that if you were slated to take your first RMD this year, you can now put it off until next year thanks to the CARES Act. As with everything IRS-related, this is more complicated than it sounds. There have been many questions about what the 2020 suspension means for those who already took out RMDs, and its impact on taxes and inherited accounts.
I believe those questions are best answered with the help of the right qualified financial advisor—ideally one who specializes on strategies geared toward retirement income. An Income Specialist can help you not only understand any possible changes to your distributions, but can also help you make sure your asset allocation is right for taking RMDs, which is more important than ever considering the current crisis.
Now, back to the point I made about the rationale for suspending RMDs for 2020 being partly flawed. For one thing, it assumes portfolios largely tied to the stock market will have recovered all or most of their losses by next year. While anything is possible, keep in mind that, historically, it takes the stock market six to seven years to recover to its previous peak after a major correction. Secondly, it’s based on the assumption that most people satisfy their RMDs by taking systematic withdrawals from a mutual fund. While many people do use this strategy, the current crisis illustrates why it can be extremely risky. It’s important to be aware there are alternative strategies that decrease this risk, and there has never been a better time to learn about them than right now!
Does the CARES Act Mean You Should Rethink Your Strategy Around Social Security or Charitable Giving?
As for Social Security, the CARES Act allows self-employed individuals to push off the employer-side liability of FICA taxes owed on employee wages from March 27th through the end of the year. While this change affects relatively few people in the short-term, it could have long-term consequences for everyone due to its potential impact on the Social Security trust fund. In fact, the coronavirus crisis as a whole has the potential to put more pressure on the trust fund, which is already on track to be depleted by 2034. After that, it would only be able to pay about 78% of promised benefits.
The current crisis may also mean your individual Social Security strategy needs to change in order for you to maximize your benefits—and to make sure they’re properly coordinated with your other sources of retirement income.
The CARES Act also includes three major changes around qualified charitable distributions, or QCDs, which are a popular strategy for satisfying RMDs among many retirees. One relates to RMD suspensions for 2020. You can still do a QCD of up to $100,000 from your IRA to a qualified charity in 2020, and it would not count as taxable income. However, since RMDs are suspended for 2020, the distribution won’t offset any RMDs. As a result, some retirees might want to skip giving a QCD this year and resume in 2021 when it will once again offset RMDs. These are decisions best discussed with the right financial advisor—ideally one who specializes in asset allocation and retirement income.
Is Now A Good Time to Draw or Borrow from Your IRA or 401(k)?
Finally, the CARES Act includes a coronavirus-related distribution exception for 2020. With this provision, IRA owners who are adversely affected by the coronavirus pandemic are eligible to take tax-favored distributions of up to $100,000 from their retirement accounts. You can recontribute the coronavirus-related distribution back into your IRA within three years of the withdrawal date and treat both the withdrawal and recontribution as a totally tax-free rollover. There are also no limitations on what you can use the funds for during the three-year period.
But what if you don’t recontribute to the coronavirus-related distribution? Well, you do have that option, but in that case, you will be taxed on the distribution amount that you don’t recontribute within the three-year window. The good news is that if you’re under age 59-and-a-half, you don’t have to worry about the well-known 10% early withdrawal penalty even if you don’t recontribute the distribution.
According to CARE Act guidelines, there are a number of scenarios under which you might qualify for the exemption. They include being diagnosed with COVID-19 or having a spouse or dependent who’s been diagnosed, being furloughed or laid-off from work, or being unable to work due to lack of childcare during the coronavirus quarantine.
The idea is that, during this crisis, the option to borrow from your retirement accounts with no tax penalty—or to draw from them with a reduced tax burden—may prove extremely helpful for some people.
As for 401(k)s, many 401(k)s and similar plans already allow participants to take out a plan loan of up to $50,000, or half of the vested account balance. Loans are then repaid over a five-year period through payroll deductions. However, the CARES Act makes two big changes to this rule. First, participants can now borrow up to $100,000 or all of their vested account balance, whichever is less, and second, you now have an extra year to pay back the loan.
Once again, the devil is in the details with all of these rules and changes, and the right financial advisor can help you identify and understand the details most relevant to you! They can help you take advantage of provisions in the CARES Act and implement other strategies to help protect your retirement and prepare it for the new “corona-economy”.