A Retiree's Guide to the CARES Act: What You Need to Know

Updated: May 31, 2020



Have you been in line at a Target or Walmart and stopped midway through to look around in shock and awe at the reality we're currently living in? Designer face masks have now replaced the latest Lululemons. Hand sanitizer stations now outnumber employees. And films like "Contagion" and "Outbreak" seem more like prescient documentaries than works of fiction. The world has changed dramatically in a matter of months making it difficult for us to digest this "new normal" way of life.


The investment landscape is no different and with the passing of the CARES Act and a few trillion dollars in stimulus money, retirees are scrambling to make sense of it all and determine what, if anything they should do to maximize their hard-earned retirement dollars.


If you'd rather not sift through several hundred pages of drab legislature, I've taken the liberty of summarizing the key components of the CARES Act and what retirees should be paying attention to.


NOTE: As almost EVERY item discussed in this post is in some way, shape or form associated with income taxes, please consult a tax professional before implementing any strategy detailed below.


1. RMDs - DELAYED



Those of you preparing to take your required minimum distribution (RMD) from your IRA or 401(k) this year now have the option to delay. The CARES Act allows retirees the option to suspend their RMDs due in 2020 until next year, an attempt at letting investors temporarily avoid paying income taxes if they aren't relying on their IRA for living expenses.


The Act even permits those who've already taken their RMD this year to transfer the full amount of the distribution back into their retirement account within 60 days and claim a tax credit for any federal tax withheld from the RMD.


WHY DOES THIS MATTER AND HOW CAN YOU BENEFIT?


First and foremost, if you don't need to take a distribution from your IRA, don't! RMDs are taxed at ordinary income tax rates so delaying, say a $40,000 distribution when you're in a 12% tax bracket can save you nearly $5,000 in taxes.


On top of that, suspending your RMD allows you to keep your retirement assets in tact and avoid the need to sell during a down market.


And if you're really savvy, you may consider converting a portion of your pre-tax retirement assets to a Roth IRA if your income is artificially lower this year.


2. RETIREMENT DISTRIBUTIONS PRE 59 1/2 - NO PENALTY!



On the other end of the spectrum, the CARES Act has made it more enticing for individuals who've been negatively impacted due to the coronavirus to withdraw funds from their retirement plans by eliminating the 10% early-withdrawal penalty on distributions up to $100,000 taken prior to age 59 1/2.


Further, taxes incurred as a result of the distribution can be repaid over 3 years. And if you're able to replenish the full amount of the distribution into your retirement account within a 3-year window, taxes paid can potentially be forgiven and refunded.


WHY DOES THIS MATTER AND HOW CAN YOU BENEFIT?


While it's generally a good rule of thumb not take withdrawals from qualified retirement plans prior to age 59 1/2, some people simply have no choice. The reality is most retirees have focused strictly on paying down debt and maxing out their 401(k)s, leaving little left over for building a cash reserve to cover unexpected costs from black swan events like the coronavirus outbreak.


If you do need to dip into your retirement assets earlier than expected, do your best to put that money back into your retirement account over the next 3 years.


On the other hand, if you have high interest debt or need cash for a down-payment on a piece of investment real estate, you could consider tapping your retirement account and using future cost savings from paying off debt or income from your rental property to reimburse yourself and potentially avoid paying income tax on the distribution.


3. 401(k) LOAN AMOUNT INCREASE



In addition to the changes in distribution rules, loans from qualified plans have also been eased, with maximum loan amounts increasing to $100,000, or 100% of your vested balance, whichever is less through December 30, 2020. Previously, the maximum dollar amount was $50,000, or 50% of the vested balance.


Repayment terms, however still remain unchanged at 5 years with the interest rates varying depending on plan guidelines (Generally speaking, expect something within a few percentage points of prime or the 10-Year Treasury).


WHY DOES THIS MATTER AND HOW CAN YOU BENEFIT?


Taking a loan from your 401(k) is no different than requesting a distribution: Investments are sold, cash is raised and subsequently distributed from your retirement account to your bank account. The only difference is the avoidance of income tax on the distribution if the loan is repaid (With interest) within 5 years.


Accordingly, be sure you have a strategic plan in place, including the intent of the funds and how you'll repay yourself, and a clear understanding of your 401(k) plan guidelines.


Examples:


Reason TO take a 401(k) loan - To pay off unsecured debt including a personal line of credit and credit cards with an average APR of 15% with a 5-year loan at 4% while remaining gainfully employed at your company for at least 5 years.


Reason NOT TO take a 401(k) loan - To buy a new boat, car or any other high-ticketed item that will start depreciating before the end of this sentence and move to Hollywood to become an actor.


4. CHARITABLE DEDUCTION NOW 100% OF AGI



If you're charitably inclined, now is the time to fork over that big gift!


Prior to the CARES Act, charitable deductions were hard to come by given the increase in standard deduction, limits on SALT and other itemized deductions. And even if you did itemize, your charitable deduction was limited to 60% of your adjusted gross income, or AGI. Thanks to the CARES Act, the deduction has now increased to 100% of AGI, plus an above the line deduction for cash contributions up to $300.


WHY DOES THIS MATTER AND HOW CAN YOU BENEFIT?


There's a good chance that charities need your donations now more than ever! If you're able, consider front-loading a few years' worth of gifts in 2020 to a non-profit, donor-advised fund or another charity of your choosing. Not only will they benefit from having additional resources to use during these challenging times, but you'll have a better chance of receiving a bigger tax break when you file your taxes next year.


5. TAX-FREE HSA DISTRIBUTIONS FOR OTC MEDS


Last but certainly not least is the expansion of reimbursable health-care related expenses. Under the CARES Act, individuals can now use their HSAs to purchase over-the-counter medicine without the need of their doctor's prescription.


WHY DOES THIS MATTER AND HOW CAN YOU BENEFIT?


Obviously, this isn't an open invitation to stock up on a year's supply of Tylenol, but definitely something to be aware of if you have an HSA as regularly purchased OTC medicine can now save you valuable tax dollars.


WHAT SHOULD YOU DO?


Before going out and taking an early withdrawal from your 401(k) or delaying an RMD, be sure it aligns with your retirement goals and objectives.


Think about it for a moment...does it make sense to delay an RMD if an IRA distribution is needed to help fund your living expenses? Would you take $100,000 out of your 401(k) early just to avoid a 10% penalty when you have plenty of cash saved for emergencies?


You can implement every financial technique in the book to perfection, however if the action doesn't fit within a carefully orchestrated financial plan, then you'll likely end up no better off than when you started.

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