Cares Act RMD, Early Withdrawal Waivers: A Closer Look

Cares Act closer look, RMD, early withdrawal

Analyzing the Cares Act's 401k-related provisions.

Required minimum distributions for 401ks and IRAs will be waived in 2020, and 401k participants would be allowed to withdraw up to $100,000 from their 401k without the 10% penalty for coronavirus-related purposes if Congress’ stimulus bill is approved by the House Friday and signed into law by President Trump.

The Senate passed the “Coronavirus Aid, Relief and Economic Security Act” (or Cares Act, as the bill is known), 96-0 in a vote late Wednesday night, but we’re not home quite yet. The House could stall it Friday by not going the “unanimous consent” route, could amend the bill and strike or change provisions related to 401ks, but that seems extremely unlikely when the provisions appear to enjoy bipartisan support.

So while President Trump hasn’t put pen to paper just yet, it’s still worth a closer look at how these significant provisions could impact 401k participants eager for help in light of financial difficulties brought on by COVID-19.

To qualify for these provisions, individuals need to fall into one of two main categories:

RMD waiver

Under the Cares Act in its current form, required minimum distribution (RMD) rules for DC plans including 401k, 403b, 457b plans and IRAs would be waived for calendar year 2020, providing relief to individuals who would otherwise be required to withdraw funds from such retirement accounts during the economic slowdown due to COVID-19.

The provision is being widely received in the market as a no-brainer.

Steve Parrish

“This is a redux from the Great Recession,” Steve Parrish, Co-Director of the Center for Retirement Income at the American College of Financial Services tells 401k Specialist. “Having the government force a retiree to take taxable distributions from an IRA when the stock market is down is neither popular nor logical. This is an easy, and temporary fix.”

Under current law, individuals generally at age 72 must take an RMD from DC plans and IRAs. The bill also includes special rules regarding the waiver period to, in essence, hold harmless those individuals (and plans) who take advantage of the RMD waiver for 2020.

“A hidden gem is that it fixes an inequity that came from the SECURE Act passed late last year,” Parrish adds. “RMDs are now also waived for IRA owners who turned 70½ in 2019 and have to take their 2019 RMD by April 1. This will save some 70-year-olds from unwittingly suffering a 50% tax penalty.”

If a retirement account holder failed to take the previously required RMDs by the end of the year, they would have to pay a penalty of 50% of the RMD amount. The SECURE Act raised the age for RMDs to 72, but someone who turned 70½ last year would have still needed to pay RMDs this April before the Cares Act.

Because RMDs are calculated based off account balances as of the end of the prior year, the ability to defer them could help millions of retirees from having to take them at a time when their portfolios are down substantially from near-record highs of Dec. 31, 2019.

“Allowing retirees to defer RMDs is a good provision for a couple of reasons,” says Sri Reddy, Senior Vice President in Retirement and Income Solutions with Principal Financial Group. “First, RMD calculations could be based off of much higher accounts values from year end, which don’t reflect today’s reality. Secondly, taking withdrawals now will lock in paper losses on the amount withdrawn and not allow retirees to participate in market gains.”

Waiver of early withdrawal penalty

The other key 401k-related provision of the Cares Act allows hardship distributions from qualified retirement accounts for coronavirus-related purposes of up to $100,000 from 401ks or IRAs for those under 59½, without incurring the standard 10% early withdrawal penalty.

While this provision may be useful to some retirement account holders facing dire financial straits, it’s not something most industry experts are excited about.

Alicia Munnell, director at the Center for Retirement Research at Boston College, told Barron’s she would have capped the early withdrawal limit at roughly $50,000 instead of $100,000, noting that the median 401k/IRA balance for those near retirement (age 55-64) is $135,000, and far lower for the median U.S. account.

Reddy also cautions against plan participants trying to take advantage of this provision.

Sri Reddy

“Unless you’re in a dire circumstance, taking a withdrawal of any significant amount after the market has dropped 30% is not a good option, and should be avoided,” Reddy tells 401k Specialist. “Instead, think of this moment as the right time to look at your other daily expenditures to right-size expense levels and stay invested.”

This isn’t a depression-like scenario, Reddy adds, “but it can feel as such when we’re experiencing such extreme fluctuations. However, I’m optimistic that by the fourth quarter, we can get back to growth.”

Parrish is similarly pessimistic when it comes to the hardship withdrawal penalty relief.

“While this offers useful relief, the concern is that 401ks are becoming the Swiss cheese of retirement accounts,” Parrish says. “Every time the government gives a new way to access pre-retirement money from a 401k, the plan starts looking more and more like a savings account, inevitably leading to holes in many people’s retirement capital.”

Income attributable to early distributions would be subject to tax over three years under the bill, and the taxpayer may recontribute the funds to a 401k within three years without regard to that year’s cap on contributions.

“This makes a lot of sense; it helps with consumer cash flows while not costing the government much in revenues,” Parrish says. “The one concern is that this will likely involve a complex payback process, leading to confusion and complications.”

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