Breaking Down the CARES Act: What it Means for Your Clients

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Like their financial advisors, many Americans are worried about both their physical and financial health amidst the economic fallout of the COVID-19 pandemic, but relief is on the way for many. On March 27, 2020, the Coronavirus Aid, Relief and Economic Security (or CARES) Act, the largest economic aid package in modern American history, took effect. Now and in the coming months the CARES Act should ease some of the current hardships Americans at all income levels are facing.

Under the legislation, investors may have access to higher-than-normal distributions and/or loan amounts from IRA and 401(k) accounts. If individuals have taken a loan from one of those retirement accounts, they can now receive extensions on repayment of that loan for up to one year. If you have clients who are investors or small business owners with liquidity needs due to hardship, the CARES Act may provide them with temporary relief.

The CARES Act includes some key provisions may allow investors to access retirement savings if they are currently experiencing adverse financial consequences related to the corona virus outbreak. We provide an overview of these CARES Act provisions below, but note that corporate retirement plans, such as 401(k)s, are not required to adopt them. Each plan will differ, so financial advisors should check with plan administrators and/or employee benefits managers (if their client is not yet retired) to determine which options may be available for clients based on their company’s plan. Many plan administrators are still assessing how to incorporate these options into their corporate plans.

Of course, clients should be advised to carefully consider all other options before tapping into retirement savings. Withdrawing retirement savings now may require liquidating investments at low values and potentially creates a tax obligation. Be prepared to assist your clients as they evaluate the options and repercussions with their overall financial well-being in mind. 

Additional Time for IRA Contributions (2019)

With Tax Day pushed to July 15, what does that mean for your clients’ IRAs and Roth IRAs? They now have until July 15, 2020 to make 2019 contributions to those accounts, so if they are facing financial hardships, they have a little extra time to contribute to those accounts. 

For those clients who can contribute the maximum amounts now, the earlier the better: it will likely allow their investment to grow more rapidly if markets improve in the coming quarter. It is key to monitor any contributions they make to IRAs after April 15 and between July 15 to ensure they are they are credited to the correct year: 2019 and not 2020. 

Required Minimum Distribution (RMD) Rules Suspended for 2020

As you may be aware, Under the CARES Act, RMDs are waived for 2020 for IRA, 401 (k), 403(b) and 457(b) plans. 

This is important to note, because RMD amounts are calculated using the balance of one’s retirement account on December 31 of the prior year. Since those values are based on the equity markets at that time, it means individuals would be required to take an RMD based on much higher account values.  That would leave many investors taking out a higher percentage of their current IRA and paying a “disproportionate amount” of taxes, according to American Retirement Association. 

Given the rapid decline in equity markets that has occurred between December 31, 2019 and March 27, 2020, the day the CARES Act was signed into law, it may makes sense for clients to forgo their RMDs in 2020 if they don’t need liquidity now. Leaving the funds invested will allow time for the market to stabilize and avoid taking an RMD at what would be a loss in 2020.

 Broadly speaking, retirement plan participants can get a waiver on their RMD:

    • If they have previously taken ongoing RMDs, they will not be required to receive an RMD in the year 2020;
    • Investors who turned 70 ½ in 2019 but didn’t take their first-ever RMD on or before January 1, 2020 can forfeit receiving their RMD’s for both 2019 and 2020;
    • Beneficiaries who are currently receiving life expectancy payments are not required to take a 2020 beneficiary RMD;

 

  • If an individual has taken their RMD for 2020 within the last 60 days, they can now roll the amount back into the same plan with no penalty or income tax due on the distribution, as long as they have not made any IRA-to-IRA or Roth IRA-to-Roth IRA rollovers over the past 12 months.

 

Caveats on RMDs: The guidelines governing RMDs are quite complex, particularly with respect to the impacts of temporary relief provided under the CARES Act. Financial advisors should encourage their clients to consult with tax professionals for additional guidance. 

IRA Beneficiaries Subject to A Five-Year Payout Rule 

If you have a client who is a “non-designated” beneficiary of an IRA inherited in 2015 or later, they may be subject to a five-year payout rule if they inherited the account from someone who died before reaching age 70 ½. That means that by 2020, the balance remaining would have to be liquidated. Under the CARES Act, there is the option to extend the distribution for a full year, meaning, clients wouldn’t have to take a required distribution until December 31, 2021. 

Hardship Distributions 

If you have a client dealing with a major financial hardship at the moment, the CARES Act allows certain coronavirus-related distributions from retirement accounts like 401(k)s and IRAs until December 31, 2020.  Dependent upon the provisions their company or 401(k) administrator’s plan, they may be able to take a COVID hardship distribution of up to $100,000 and the tax liability can be spread over three years, if so desired.

 These COVID hardship distributions are available to individuals age 59 ½ or younger under the following conditions:

  • Your client, their spouse, or a dependent has been diagnosed with COVID-19;
  • Your client has experienced adverse financial consequences as a result of being quarantined, laid off, furloughed, given reduced work hours, or is unable to work due to a lack of childcare;
  • Your client is a business owner who has had to reduce operating hours or close their business;
  • Possible additional factors as determined by the Treasury Secretary

Under normal circumstances, anyone under the age of 59 ½ would be penalized at a 10% early withdrawal penalty rate, but under the CARES Act, it is waived as long as a distribution is taken by December 31, 2020. 

It’s important to remind clients that they will have three years to repay the amount withdrawn back into qualified retirement plans and IRAs without incurring income tax on the distribution, plus, the amount repaid will not be subject to contribution limits normally imposed. If they are unable to re-contribute the amount within that three-year period, they will owe income tax on it; however, the distribution can be reported as taxable income evenly over the years 2020, 2021, and 2022. 

Clients and their financial advisors need to check with their retirement plan administrators to find out if their plan allows for hardship distributions for COVID-19 related reasons. Additionally, they should consider the tax liability that will occur if they are not able to repay the amount to the plan account. 

Loans from Qualified Retirement Plans

Loans against a 401(k) or other qualified retirement plan are impacted, too. If clients already have a plan loan outstanding with an amount due, they may be able to delay that loan repayment for up to one year through December 31, 2020. Also, if they have a retirement plan that allows for loans, limits may have been increased to as much as $100,000 or the lesser amount of 100% of an individual’s vested account balance as allowed under the CARES Act. 

If your client is an investor that needs liquidity, the CARES Act has a few options, but it is imperative they consider the advantages and drawbacks of a plan loan vs. a hardship withdrawal.

Need more information? Visit B. Riley Wealth Management.

B. Riley Wealth Management does not provide tax or legal advice. Consult with your tax or legal professional. The preceding is an overview compilation of CARES Act information available at the time of publication and does not address all aspects of the CARES Act provisions. For complete details, visit: www.congress.gov or www.treasury.gov 

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