Time to Review Clients’ Retirement Accounts

The COVID-19 pandemic has led to volatile markets, resulting in retirement accounts with much smaller balances than only a few short months ago. In response to the economic fallout stemming from the pandemic, Congress passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which was signed into law on March 27, 2020. The CARES Act was primarily aimed at providing quick and substantial relief to individuals and businesses affected by the economic shutdown in response to the spread of COVID-19. Several relief measures have a significant impact on clients’ ability to benefit from their retirement accounts. You can provide significant peace of mind to your clients by keeping them informed about how they can use their retirement funds now without penalties if necessary, as well as benefit from other tax relief provided by the new legislation.

The CARES Act creates new distribution options for those adversely impacted by coronavirus, expands the availability of plan loans, and waives required minimum distributions for most retirement plans for 2020.

Early Distributions. Pursuant to Section 2103(a) of the CARES Act, the 10% early distribution penalty tax under I.R.C. Section 72(t) that would otherwise apply to the majority of distributions made before a participant turns age 59 ½ is waived for “coronavirus-related distributions” (CRD) made at any time during 2020 from qualified retirement plans for distributions of up to $100,000. The distribution option is permissive, not mandatory, for eligible plans such as IRAs, 401(k)s, 403(a) and (b) plans, and 457 plans.

A CRD is a distribution from an eligible retirement plan made during 2020 to a qualifying individual who is diagnosed with coronavirus, or whose spouse or dependent has been diagnosed with it, or who has experienced adverse financial consequences from a coronavirus-related quarantine, furlough, layoff, work reduction, business closure or reduction in hours (for business owners) or an inability to work due to lack of child care related to coronavirus. The distributions will be subject to income tax, but the qualifying individual may opt to spread the payments evenly over three years rather than having to pay it all in 2020. The participant may also recontribute the distributed funds to the retirement plan or another retirement plan (with an exception for 457 plan distributions), by a single rollover or multiple rollovers, within three years of the date of the distribution regardless of any contribution limit established by the plan.

Loans. During the 180-day period from the date of enactment of the CARES Act, plans can increase their loan limits to the lesser of $100,000 or 100% of the participant’s vested account balance for qualified individuals, up from the previous limits of $50,000 or 50% (note that loans are not permitted from IRAs) for participants adversely affected by coronavirus as discussed above. Qualified individuals with an existing loan from a retirement plan that is due to be repaid by December 31, 2020 can delay repayment by one year. Later repayments will be adjusted to reflect the delayed due date plus interest accruing during the delay. In addition, the one-year period of delay in repayment is disregarded in determining the maximum five-year loan period.
Required Minimum Distributions. For participants in 401(k), 403(a) and (b) plans, 457, and IRAs (not defined benefit plans), the CARES Act waives required minimum distributions (RMDs) for the calendar year 2020. Under the new SECURE Act, effective January 1, 2020, account owners are typically required to take an RMD from their plan upon reaching age 72. The CARES Act waiver also applies to RMDs for account owners who reached age 70 ½ in 2019 but deferred taking an RMD in 2019 until April 1, 2020. Normally, account owners in this category would also have to take a second RMD for 2020 by December 31, 2020, but this RMD is waived as well.

Under the previous tax law, an RMD taken by an account owner cannot be rolled back into an IRA unless this is done within 60 days after the distribution, and a rollover from one IRA to another IRA (or from one Roth IRA to another Roth IRA) can be done only one time per year (365 days). Under the CARES Act, those who had already taken an RMD prior to the passage of the new law are allowed to roll it over into the original account within 60 days, and this time limit was extended by IRS Notice 2020-23 for distributions—including RMDs—taken between February 1st and May 15th if the rollover occurs by July 15th. If the account owner took an RMD in January, it may not be returned unless the IRS provides additional relief.
Although the once-per-year IRA rollover rule is still in effect, if the account owner has already used their IRA rollover, they are permitted to do a rollover to a non-IRA retirement account such as a 401(k). The once-per-year rule does not apply to RMDs taken from a 401(k) or to Roth conversions.

The waiver is also applicable to designated beneficiaries who have inherited retirement accounts. Further, 2020 is not counted for purposes of the post-death payout “five-year rule” applicable to non-designated beneficiaries[1] when the owner died before his or her own required beginning date.

However, the CARES Act has no impact on the new 10-year payout rule required by the SECURE Act, which precludes most non-spousal beneficiaries from stretching their distributions over their lifetime, as 2020 is the first year that non-eligible designated beneficiaries [2] would be subject to that rule when they inherit a retirement account. Because the 10-year payout does not start until the year after the year in which the account owner died, 2021 counts as year one rather than 2020.

Note: The CARES Act does not affect the ability of clients who are 70 ½ years old to make an annual qualified charitable distribution (QCD) of up to $100,000 from his or her IRA directly to a qualified charity in 2020 without taking the distribution into taxable income. However, the suspension of RMDs reduces the incentive for doing so because the distribution will not offset the client’s RMD, thus enabling the client to avoid taxable income. However, a QCD will reduce clients’ taxable IRA balance, so it will still provide a tax benefit to them. Further, under the CARES Act, for 2020, individuals who itemize their deductions can elect to deduct up to 100% (up from 60%) of their adjusted gross income for cash charitable contributions, so if clients choose to take a cash distribution from their IRA and contribute that cash to a qualified charity, they can potentially completely offset the tax attributable to the distribution using the charitable deduction.

Review Beneficiary Designations. In any discussions with clients about their retirement accounts, it is always prudent to remind them to regularly review their beneficiary designations. As you know, life circumstances can change very quickly. If a marriage, death, or divorce has occurred since they last reviewed their beneficiary designations, they should give some thought to whether their current beneficiary designations are still consistent with their estate planning objectives. It would be unfortunate if their retirement funds went to an ex-spouse or someone else a client no longer wants to benefit. In addition, alternate beneficiaries should be named in case the primary beneficiary passes away before inheriting the account.

In addition, if a trust is the beneficiary of their retirement account, make sure your clients are aware of the new 10-year rule established under the SECURE Act, which precludes most non-spousal beneficiaries from stretching the distributions over their lifetime. Before the SECURE Act was passed, some clients may have created trusts with “conduit” provisions so that the trust would qualify as a designated beneficiary of a retirement account, allowing the RMDs to pass through to the trust’s primary beneficiary for their individual life expectancy. Now, conduit trusts are ineffective after ten years, at which point the retirement account balances must be paid directly to the trust’s beneficiaries, possibly increasing their income taxes and making the funds available to claims by creditors or divorcing spouses. If your clients were utilizing this type of trust in their estate planning, now is a good time for a review of their documents, as this type of trust may no longer achieve their goals.

Now Is a Great Time to Meet with Clients

As a result of the uncertainty, clients are likely in need of reassurance and advice, so it is an opportune time to meet with them—virtually or by telephone if they prefer. You know your clients’ circumstances, both financial and personal, so you are perfectly positioned to advise them about the best strategies for their retirement plans. We have all been affected by COVID-19 in one way or another: Strengthen your relationships with clients by empathizing with the stress they may be feeling and letting them know that you are available to help. Clients are best served by a collaborative team, so please contact us if we can help your clients with their estate planning needs, whether this involves their retirement account or any other concerns.

[1] The plan participant’s estate, a charity, or a trust that does not qualify as a see-through trust.
[2] Beneficiaries who do not fall within one of five categories (surviving spouse, minor child of participant, disabled beneficiary, chronically ill individuals, beneficiaries less than 10 years younger than the plan participant) of beneficiaries that are still allowed to use the life expectancy payout.