In response to the halting U.S. economy, set off by the coronavirus pandemic, the federal government passed a massive emergency funding bill to protect and support American businesses, hospitals and individuals. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) is a far-reaching bill with over 1,000 pages of text that detail the funding, loans, and tax provisions designed to provide economic relief. The CARES Act also includes changes that will impact individuals retirement income strategies, including how they use their IRAs and 401(k)s.
Four main areas of retirement planning impacted by the CARES Act are: RMD’s, 401(k) loans, the new coronavirus-related distribution exception, and charitable giving. Let’s dive into each of these areas.
- Required Minimum Distributions (RMDs)
What changed: Perhaps the biggest retirement-related change the CARES Act made was suspending all required minimum distributions (RMDs) from retirement accounts for 2020. These accounts include 401(k)s, inherited retirement accounts, 403(b)s and 457(b)s. The provision is very broad and is not a push off to 2021 – you will not have to take two RMDs next year. In essence, you do not owe any RMDs for 2020, inherited or otherwise.
The impact: The biggest impact from waiving RMDs for 2020 is that retirees can leave their retirement accounts alone for another year. It can be a huge benefit to retirees if they leave their investments alone for a year and let them recover from the market downturn. They still have the flexibility to pull out as much money as they need from their retirement accounts in 2020, they just aren’t required to take out anything.
For more information on the RMD changes in the CARES Act, read this Forbes article: CARES Act Drastically Changes Required Minimum Distributions for 2020.
- 401(k) loans
What changed: Many 401(k)s and other defined contribution plans allow participants to take out a plan loan of up to $50,000 or half of their own vested account balance, whichever is less. Typically, loans are then repaid over a five-year period through payroll deductions. The CARES Act made two big changes as it relates to 401(k) loans:
- First, plans now allow a participant to borrow up to 100% of his or her vested account balance or $100,000, whichever is less. These expanded limits only apply to loans made from March 27 to September 23, 2020.
- Second, the CARES Act gives people an extra year to pay back their loans if 2020 was one of the five years for their outstanding loan repayment, essentially creating a six-year repayment period with no more payments due in 2020.
The impact: The 401(k) loan amounts expansion and delayed loan payment can provide relief in two meaningful ways.
- Borrowing money from your 401(k) for short-term needs is not always ideal, but in a crisis – such as a worldwide pandemic – it can be a better strategy than taking out personal loans or credit card debt. The benefit of a 401(k) loan is that while you owe interest on the loan, it pays back into your own retirement account. You don’t have to pay someone else to borrow your money, you pay yourself to borrow money. Loan funds are not taxable as ordinary income when they come out of the plan and can be repaid, whereas normal distributions are taxable and typically cannot be put back into the plan easily.
- Second, granting individuals another year for 401(k) loan repayments means they don’t have to remove money from their paycheck. This allows for higher cash flow and paychecks for the rest of the year.
- New coronavirus-related distribution exception
What changed: A coronavirus-related distribution is one that is made after January 1, 2020 and before December 31, 2020 for an individual or their spouse who is diagnosed with COVID-19 or if they experienced adverse financial consequences caused by the coronavirus, such as being laid off, having hours reduced, being quarantined or furloughed.
- Up to $100,000 can be withdrawn from a retirement account and be exempt from the 10% penalty tax if the distribution is taken before age 59.5.
- The distribution will be automatically spread out over the next three years from a tax perspective. However, you can opt to treat the entire distribution as taxable in 2020.
- This distribution can come from an IRA, which typically does not allow plan loans. You can repay the coronavirus-related distribution for up to three years after the day of distribution. The repayment would be treated as a rollover in 2020, so you might have to file an amended tax return for 2020 if you repay in a few years to get your taxes back.
The impact: For many people, this will open up a large distribution amount from IRAs, which usually don’t allow for loans. As people are laid off, experience decreased income due to the economic changes, or are otherwise financially impacted by the coronavirus, they can tap into their retirement accounts without penalty tax and repay it over a few years. The ability to repay the retirement funds is very important. You can use the funds for a short-term need, and you can repay it, so you don’t wipe out your long-term retirement funding.
- Charitable giving
What changed: The CARES Act includes three major changes to charitable giving.
- The first change relates back to RMD suspensions for 2020. You can still do a qualified charitable distribution (QCD) of up to $100,000 from your IRA to a qualified charity in 2020. The direct distribution to a charity would not show up as taxable income to the individual. However, since RMDs are suspended for 2020, the distribution won’t offset any RMDs.
- Second, the CARES Act created a new above-the-line deduction of $300 for charitable contributions.
- Third, the CARES Act allows for cash gifts to most public charities of up to 100% of adjusted gross income in 2020. This is normally limited to 60% of AGI.
The impact: The new deduction allows those who do not itemize their tax deductions to benefit from a tax deduction of up to $300 per individual from donating cash to a charity. Less than 10% of Americans are expected to itemize in 2020, so this could benefit many givers. If you have a large taxable event in 2020, like the sale of a business, it could make sense to take advantage of the one-time higher AGI limit for cash gifts. While it is not advisable to do a 100% AGI gift for most people, you can plan on making a large gift to charity in the future to leverage the new 2020 limit.
The Tough Get Strategic – Financial Strategies for a Market Downturn
When the going gets tough, the tough get strategic. Headlines you read at breakfast might be contradicted by lunch, and the ups and downs of the market could give anyone vertigo. But now is not the time to panic – now is the time to take a deep breath and strategize.
Any farmer knows that dying corn stalks are part of the year. Any surgeon knows that scar tissue is part of the process. And any wise investor knows that down markets aren’t the end of the world, but part of the natural rhythm. What goes up must come down, and back up again, at some point.
There’s a lot to be done in this time. Warren Buffett’s advice to be fearful when others are greedy and to be greedy when others are fearful applies in some sense during even this dip, especially if done strategically. Let’s look at a few strategies for a market downturn that individual investors can embrace in this time.
What’s Your Re-fi Password?
The Fed cut interest rates to near zero in an effort to free up money in the economy. At the time of this writing, the interest rate sits under 0.25%, which is the deepest and quickest rate cut since the financial crisis in 2008. On the level of the individual investor, this can be a great opportunity to refinance. Mortgage rates are hovering around 3.5% and banks are offering deals on other kinds of refinancing as well.
For a lot of us, the possibility of a Roth conversion waits in the same dusty corner as getting that dentist appointment and checking the air pressure on our tires. The money involved seems distant (for some of us) – its numbers we see on our computer or paycheck, not cash in hand.
But a trough like this can be the best opportunity to act on a Roth conversion. As the market dips, your traditional IRA is going to dip along with it, which means you would pay less taxes on a Roth conversion. If you’ve been meaning to do it all year, now’s the time, especially because we don’t know how quickly this economic event will recover.
A Plentiful Tax Loss Harvest
Tax-loss harvesting is a helpful and often underused strategy during down markets. Take an ailing equity and sell it at a loss, then take that tax loss and use it against an equity where you had a gain.
You can even let those losses roll year over year, which isn’t a bad idea in uncertain times. It’s a bit counterintuitive, but this is the kind of loss that can be good to have around.
Even on the Rainy Days
It doesn’t all have to be bad news – but it depends on your perspective. Remember, when the going gets tough, the tough get strategic. Try to see your way through the initial emotional fog around this downturn – things will become clear, and patience is your most important financial tool at the moment.
We are here to work through these options with you – and these are only a few strategies for a market downturn. We are always here to talk through how you can best achieve your financial goals.
Did You Know:
SEVEN MONTHS – The worldwide flu outbreak that occurred in the fall of 1918 killed 50 million people globally, including 675,000 Americans. The health crisis was a primary cause of a 7-month recession in the USA that lasted from August 1918 through March 1919 (source: National Bureau of Economic Research).
TO NEAR ZERO – The Fed cut its key benchmark interest rate to “0-to-0.25%” on Sunday 3/15/20. The only other time in American history that the Fed has cut rates to near zero was on 12/16/08, a level that was maintained for 7 years until they raised rates by 0.25 percentage points on 12/16/15 (source: Federal Reserve).
“Consider it pure joy whenever you face trials of many kinds, because you know that the testing of your faith produces perseverance” – James 1:2
“Things turn out best for the people who make the best of the way things turn out” – John Wooden
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