COVID-19 Related Tax Savings on Early Withdrawals from your IRA, 401K or 403B

2020 is a year that most of us will never forget. Besides the many medical issues created by the pandemic, it also created economic hardships for many Americans. With millions of Americans out of work it forced some to decide between paying their current bills and saving for tomorrow. This struggle forced many people to take money out of their retirement accounts in an effort to make ends meet.

As you may know, if you take money out of your IRA, 401K or 403B before you’ve reached the age of 59 ½, not only is it taxable to you, but you are also subject to a 10% early withdrawal penalty. For taxpayers who are already struggling to make ends meet, this is a tough pill to swallow.  Thankfully as part of the CARES Act, there is some additional relief to taxpayers who had to take early withdrawals from their retirement plans if they are a Qualified Individual.

What is a qualified individual?  According to the IRS you are a qualified individual if:

• You are diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention;
• Your spouse or dependent is diagnosed with SARS-CoV-2 or with COVID-19 by a test approved by the Centers for Disease Control and Prevention;
• You experience adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having reduced work hours due to SARS-CoV-2 or COVID-19;
• You experience adverse financial consequences as a result of being unable to work due to lack of childcare due to SARS-CoV-2 or COVID-19; or
• You experience adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to SARS-CoV-2 or COVID-19.

For those qualified individuals who took distributions between January 1, 2020, and December 31, 2020, the early withdrawal penalty is waived on the first $100,000 taken in distributions. Furthermore, you are allowed, but are not required to spread out the distribution over three years. For example, suppose you took $30,000 out of your 401K in 2020 due to one of the scenarios mentioned above. You do not have to pay the $3,000 early withdrawal penalty, and you only have to pick up $10,000 in income in 2020. You can then defer the remaining $20,000 to 2021 and 2022.

Maybe your financial situation has turned around and you’d like to put that money back into your retirement account. The CARES act provides some relief there as well.  As long as you pay the money back within 3 years time of the initial distribution, you can get the taxes paid from those distributions back by filing an amended tax return for those years.

If you decided to take a loan out of your retirement account and are a qualified individual, the CARES Act has something for you as well. For any loan taken out after March 27, 2020, you can delay making certain loan payments for up to a year. The maximum amount you may be eligible to take out is also increased from $50,000 to $100,000.

If you think you may be eligible for relief as a qualified individual and need help regarding the tax treatment of those distributions or in the repayment of those distributions, please do not hesitate to reach out. You can contact Charlie Eisenhart, Principal and leader in McKonly & Asbury’s tax segment at (717) 761-7910 or by emailing ceisenhart@macpas.com.