IRS Expands Eligibility For IRA & 401(k) Loans & Distributions In Covid-19 Guidance

The Internal Revenue Service’s official guidance on Covid-19-related 401(k) and Individual Retirement Account loans and distributions is out, and it expands the list of who can qualify for special tax relief. Newly eligible: those who’ve had a job offer rescinded or a job start date delayed due to the coronavirus. 

The CARES Act, the $2 trillion stimulus package passed in late March, opened the door to taking huge sums out of retirement accounts. The IRS issued FAQs on Covid-19-related IRA and 401(k) loans and distributions in early May.

Now IRS Notice 2020-50, Guidance for Coronavirus-Related Distributions and Loans From Retirement Plans Under the CARES Act, is more welcome news for folks struggling financially from the Covid-19 pandemic, and for employers who are fielding questions about the new rules. There’s a sample letter employers can ask employees to sign to certify that they’re eligible. And there are detailed examples of how tax treatment works for distributions and recontributions, as well as a safe harbor rule for loan deferrals.

The need is there. Fidelity Investments found that 295,000 (1.2%) of its 401(k) plan participants took a CARES distribution in May. The average distribution was $12,500; more than 6,000 took the full $100,000. Manufacturing and health care workers were by far the highest users of CARES distributions. Loan activity was high too in May: 17,500 took a CARES Act loan, with an average $16,500 loan amount. And 91,000 participants deferred their payments on loans as the CARES Act allows.

Under the CARES Act, you can take up to $100,000 as a distribution in calendar year 2020, and the normal 10% early withdrawal penalty for folks under 59 1/2 is waived. You’ll still owe income taxes on the money you take out, but you’re allowed three years to pay the taxes. If your circumstances improve, the law says that you can redeposit the money you took out back into your retirement account (or another eligible retirement account) as a rollover contribution within three years.

The law also increases the amount you can borrow from your 401(k). Through September 22, 2020, you can borrow 100% of your account balance up to $100,000 (less any outstanding loans). That’s up from the normal $50,000 limit. In addition, for outstanding loans, the due date for payments due through December 31, 2020 can be delayed up to one year.

The new IRS guidance reiterates that an individual must actually be a qualified individual to obtain favorable tax treatment. In other words, not just anyone can raid their 401(k) or IRA. You must meet the requirements to be eligible.

Under Notice 2020-50, a qualified individual is anyone who –

• is diagnosed, or whose spouse or dependent is diagnosed, with the virus SARS-CoV-2 or the coronavirus disease 2019 (collectively, “COVID-19”) by a test approved by the Centers for Disease Control and Prevention (including a test authorized under the Federal Food, Drug, and Cosmetic Act); or
• experiences adverse financial consequences as a result of the individual, the individual’s spouse, or a member of the individual’s household (that is, someone who shares the individual’s principal residence):
• being quarantined, being furloughed or laid off, or having work hours reduced due to COVID-19;
• being unable to work due to lack of childcare due to COVID-19;
• closing or reducing hours of a business that they own or operate due to COVID-19;
• having pay or self-employment income reduced due to COVID-19; or
• having a job offer rescinded or start date for a job delayed due to COVID-19.

Employers can choose whether to implement these rules (most are choosing to do so). If your employer doesn’t, you can still claim the tax benefits when you file your tax return. For more details, there’s the 19-page formal guidance and the IRS FAQs.

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