Special Rules for 2020 Retirement Distributions
Required Minimum Distributions
Generally, a taxpayer who has reached the age of 72 or has inherited an IRA must take annual taxable distributions from his/her retirement account. For 2020, The CARES Act waives the requirement to take such a payment. This waiver applies to IRA’s, 401(k)’s, 403(b)’s and inherited IRA’s.
COVID 19 Related Retirement Distributions
Normally, in addition to paying income tax, a taxpayer under the age of 59 ½ must also pay a 10% penalty on any retirement account distributions. For 2020, The CARES Act allows for a penalty free COVID related distribution of up to $100,000. You must still pay income taxes on the distribution but will have the option to pay the income tax in 2020 or ratably (equal increments) over a three-year period. Remember, not every distribution qualifies for the special tax treatment. Qualified distributions must meet one of the following requirements:
1) You, your spouse or your dependent were diagnosed with COVID-19 by a test approved by the CDC;
2) You experienced financial hardship from being quarantined, furloughed, laid off or your work hours were reduced as a result of Covid-19;
3) You experienced adverse financial consequences due to lack of childcare as a result of Covid-19; Or,
4) You experienced adverse financial consequences as a result of reduced hours or the closing of a business that you own or operate.
In an interesting twist, The CARES Act provides you the option to repay the withdrawn funds back to your retirement account within 3 years from the date you received the distribution. This provision can create some tax return craziness. Consider, if you repay the distribution before you pay the tax on it, then the distribution is effectively ignored for tax purposes. It is analogous to a loan. On the other hand, if you have recognized the income from the distribution on a tax return and then decide to pay back the distribution, you will need to amend any tax return that you had previously included the distribution (or part of the distribution) as income.
Example 1. You took a qualified distribution from your 401K in May 2020 due to job loss. In February 2021, you decided to repay the money to your 401K. The distribution will not be taxable on your 2020 return as you returned the full amount to your 401K before the due date of your 2020 tax return.
Example 2. In 2020 you took a qualified distribution from your IRA and you choose to pay the tax ratably over the next 3 years. In this example, 1/3rd of the income received from the withdrawal will be included in your 2020 taxable income. In December of 2021 (after you have filed your 2020 tax return) you repay the full amount back to your IRA. In this example, you will not include any taxable income from the distribution on your 2021 tax return. An amended return for tax year 2020 will need to be filed to recover the tax paid in previous years on the distribution.
Example 3. In 2020 you take a qualified distribution from your retirement account and you chose to report the distribution over a 3 year period (2020, 2021 and 2022). In tax year 2022, you repay the full amount to an eligible retirement plan. Amended returns will be needed for 2020 and 2021 to claim a refund of the tax already paid on the distribution and you will not be required to include any amount of the distribution on your 2022 tax return.