The new coronavirus outbreak and economic measures to contain it could have a significantly negative impact on retirement preparations for millions of Americans.
Account balances have been depleted by the stock market collapse. Many people now need to tap into their accounts to make ends meet. Others, facing layoffs or reduced hours, won’t have the income to make investment contributions.
Still others, in their early 60s, will start taking Social Security benefits as soon as they can, locking in lower monthly payments for the rest of their lives.
But the fallout isn’t entirely bad.
The government has introduced several temporary changes that could help people shore up their finances and manage their retirement accounts more effectively.
Here’s what is changing:
RMDs put on hold
One change involves the required minimum distributions that investors normally must begin after reaching age 72 with Individual Retirement Accounts and some 401(k)-style plans.
Under provisions of the new federal CARES Act, RMDs may be suspended for 2020 to help investors rebound from stock-market losses.
This is notable because those withdrawals would have been based on account balances as of Dec. 31, 2019, when the stock market was much higher.
The new one-year RMD waiver is a “huge help” for many seniors who had been facing taxes on higher account values, said Ed Slott, a certified public accountant and founder of IRAHelp.com.
“Now, clients can sit out a year and avoid the tax bill on their 2020 RMDs, if they wish,” he said.
Withdrawal penalties eased
President Trump signs the CARES Act, providing $2.2 trillion in economic relief during the coronavirus pandemic.
Under the CARES Act, investors in workplace retirement plans and IRAs can withdraw up to a combined $100,000 in 2020, from all such accounts, without incurring the usual 10% early withdrawal penalty. The penalty normally applies for people under age 59 1/2 or 55 in some cases with 401(k)-style plans.
However, not everyone will get this break.
“The affected participant or IRA owner (including a spouse or dependent) would need to either be diagnosed with SARS-COV-2 or COVID-19 or experiencing adverse financial consequences as a result of an event,” noted Fidelity in a commentary. These consequences include a layoff, furlough, reduced work hours, a lack of available child-care assistance or a business closing in the case of self-employed individuals.
Ordinary income taxes still apply on permanent distributions, but the impact may be spread evenly over three years. As an option, investors can repay some or all of the withdrawn money back into a retirement plan within three years to avoid the tax bill and rebuild their account balances.
“That’s why this provision was put into the bill — to help people get back on track for retirement,” said Meghan Murphy, a Fidelity vice president for global thought leadership. “It’s like a mortgage: What you get approved for might be much more than you need.”
Larger 401(k) loans
In most 401(k) plans, employees can take out loans rather than making permanent withdrawals. Loans can be a tempting way to access cash quickly. Among the benefits: There’s no lengthy application process, the interest you pay goes back into your account rather than to a bank and the transaction isn’t included on your credit report.
Under the new CARES legislation, the amount employees may borrow from their 401(k) plans increases to $100,000 this year from $50,000 before (assuming there’s at least that much in the account).
Many plans only allow employees to borrow up to a certain percentage of their balance, such as 50%, though that threshold is waived this year, Murphy said. Also, the legislation allows loan repayments to be delayed for one year.
Taking out a 401(k) loan isn’t necessarily a great option. If the stock market rebounds while your money is out on loan, you could miss some juicy gains. And if you can’t or don’t repay a loan, the balance would be taxed and that 10% penalty might apply down the road.
Prior to the new coronavirus outbreak, relatively few 401(k) participants had taken out loans, including during the 2007-2009 recession, Murphy said. But the unprecedented pressures that now apply, including heightened health-care needs, could change that.
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This year, the deadline for filing federal income-tax returns and paying taxes has been delayed from the normal April 15 date to July 15. Many states, including Arizona, have adopted the same schedule.
As one consequence, July 15, 2020, also becomes the deadline for making 2019 contributions retroactively to IRAs though not for workplace 401(k) plans. This isn’t a huge benefit, as relatively few Americans max out their IRA contributions, but it’s a modest advantage for those who do.
Also, the optional ability to make tax-free transfers from an IRA to help a favored charity has been retained. This provision remains open to seniors 70 1/2 or older. It has proved popular among some people who don’t need to live off their withdrawals.
Stress for some 401(k) plans
The new rule changes provide relief, or at least more flexibility, for workers and retirees with retirement accounts. Yet many employers, especially small businesses, might need assistance too, and they are eager to get it.
The American Retirement Association, which includes affiliates such as the Plan Sponsor Council of America, has asked the Treasury Department to amend regulations to give employers more flexibility during the new coronavirus outbreak, including the option of suspending matching-fund contributions they make to employee accounts.
Many businesses closed their offices or transitioned quickly to telecommuting, which hindered their ability to amend plans properly and provide notices to workers, meaning that matching-fund obligations continue, the American Retirement Association said in a letter to the Treasury.
Without a relaxing of these and other rules governing 401(k) programs, “The financial crisis facing employers might force them to terminate their plans rather than keeping them intact but partially frozen, until the business recovers,” the letter warned.
The American Retirement Association and its member employers and financial-service companies don’t want to see 401(k) plans scuttled, which they fear could be a disaster for the long-term goals of millions of people. Rather, they seek “breathing room” for hard-pressed 401(k) sponsors, allowing time for them to recover.
If that happens, many employees wouldn’t receive matching funds, at least for a while.
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