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Coronavirus

The CARES Act and What It Means for Financial Planning

The CARES Act and What It Means for Financial Planning

Author: Ryan Decker, Advisor, Private Client Services

As the Covid-19 pandemic gripped the world, President Trump signed into effect a $2 trillion disaster relief package. Known as the Coronavirus Aid, Relief and Economic Security Act, or CARES Act for short, the legislation is designed to offset the economic jolts resulting from the pandemic and includes help for Americans hit with loss of income.

With jobless claims reaching into the millions for the month of March 2020, the CARES Act promises to deliver some relief in the form of stimulus checks. Offered mainly as a way to bolster the struggling economy, payments of $1,200 will be made to individuals with an annual adjusted gross income (AGI) under $75,000 ($150,000 per couple) who also can’t be claimed on another adult’s income tax return. Refunds are then prorated for wage earners with annual AGI up to $99,000 per individual and $198,000 per couple. Recipients are also eligible for a $500 per child credit.

However, even these amounts won’t cover the expenses of jobless workers for long and certainly don’t help higher wage-earning families who may also be struggling at this time. That’s where other provisions in the act come into play, but you’ll want to make sure you have a solid understanding of the impact to your complete financial picture before acting, as many have long-term financial planning implications.

Should I Take a Qualified Withdrawal from My Retirement Plan?

The CARES Act authorizes withdrawals of up to $100,000 from eligible retirement plans to help qualified individuals offset costs incurred from coronavirus related events.

The list of eligible recipients includes those who are diagnosed with Covid-19 or someone who has a spouse or dependent who is diagnosed with the virus. Individuals who have been negatively impacted financially through job layoffs or furloughs, for example, are also eligible.

While it might seem easy to justify taking money from retirement savings since it represents one of your largest assets, it may not be your best move. It is highly likely that withdrawing funds will involve some sort of future trade-off, such as working longer or lowering your retirement income.

One advantage is the option to pay back any withdrawals you make over a 3-year period, but here again, caution is warranted.

When you take an in-service withdrawal, the 10% early penalty is waived as is the 20% mandatory tax withholding, but you will be fully taxed on your year-end return as if that distribution were regular income. The only difference is that tax payments will be spread equally over three years.

However, if you do refund the plan, you’ll need to go back and amend the tax returns in order to get the refund on the income taxes paid. The administrative work is likely to be burdensome for both you and your accountant.

During these times, it’s also important to not take on overdue risk. For example, some investors may try to make up for losses by making risky investment choices they wouldn’t normally make. Sticking to your risk tolerance and long-term asset allocation is the best course of action if you decide to take a withdrawal.

Additionally, employers have the right to say “no” when it comes to allowing qualified withdrawals, so even if this is the best course out of Covid-19 financial troubles for you, the option might not be available.

We recommend talking with your financial advisor to see if taking a qualified withdrawal from your retirement plan is a good option for you based on your current situation and long-term financial goals.

Think Carefully Before Borrowing from Your Retirement Savings

In a measure similar to allowing qualified plan withdrawals, the CARES Act also supports an increase in retirement plan loans up to 100% of the vested account balance not to exceed $100,000. While borrowing from your plan is a step that should be considered carefully, it is often preferable to a qualified withdrawal.

For one thing, the interest you pay goes back into your account, so in theory, you become both the lender and the borrower. Second, you can stretch loan repayments over 5 years and delay any payment from the date of enactment through the end of 2020 for up to one year.

Additionally, in contrast to withdrawals, you’re replacing the distribution through loan payments. One of the biggest risks to the in-service withdrawal is that you may not have the liquidity to repay the funds in the future, leaving you with a hefty tax bill as well as a lower retirement plan balance.

Before deciding to borrow against your retirement fund, be sure to speak with your financial advisor to fully assess the impacts to your future.

CARES Act Waives Required Minimum Distributions and Amends the 5-Year Rule

If you’re currently taking a Required Minimum Distribution (RMD) from your retirement account, the CARES Act has some important provisions for you.

The bill grants a waiver for participants in retirement plans such as traditional IRAs, SEP IRAs and 401(k)s. That means if you were required to take a minimum distribution this year, you no longer need to do so. Better yet, if you turned 70½ last year and haven’t yet taken your required RMD, you can skip both the 2019 distribution as well as the one required in 2020.

There are two main benefits to delaying RMDs. First, you’re giving your account time to recover from the incredible market volatility witnessed in the wake of the COVID-19 pandemic.

Second, RMDs taken in 2020 would be based on account values as of December 31, 2019. The Dow closed out last year at 28,462 compared to 21,917 on March 31. As such, plan owners would be forced to pay tax on a much higher percentage of their balance. Skipping the RMD for 2020 reduces your tax burden for this year.

Additionally, the bill applies to beneficiaries taking stretch distributions from inherited accounts. The CARES Act suspends the 5-year rule for individuals who have inherited retirement accounts through a will or who were a beneficiary of a trust.

Normally, these funds would need to be withdrawn over a 5-year period, but under the CARES Act, beneficiaries now have an additional year to withdraw the total balance. So, in essence, the 5-year rule becomes a 6-year rule for those who inherited accounts from 2015 to 2020.

CARES Act Relaxes Limitations for Charitable Contributions

The pandemic has hit many non-profit organizations especially hard, as fundraising events have been canceled and stock donations are likely to decrease due to the market drop. To make it easier for people to donate to organizations in need, the CARES Act is relaxing limitations for qualified charitable contributions. Starting in tax year 2020, the IRS is allowing a $300 above-the-line tax deduction for charitable cash donations, whether or not you itemize on your tax return.

Additionally, the CARES Act temporarily increases the income deduction limit on cash donations made to 501(c)(3) organizations to 100 percent of AGI. In theory, an individual could effectively eliminate any 2020 tax liability with charitable donations. Any additional contributions above 100% of a taxpayer’s AGI can be carried forward for 5 years.

Since Congress doubled the standard deduction in the Tax Cuts & Jobs Act of 2016, itemization of charitable contributions has become less relevant as the majority of taxpayers now take the standard deduction. Although the deduction is limited to $300 and the relative tax savings may be insignificant, every little bit helps.

It should be noted that Qualified Charitable Contributions must be made in cash and cannot fund donor-advised funds or 509(a)(3) “supporting organization.”

The CARES Act and You

While the CARES Act offers American households several provisions for maintaining a more positive financial outlook during the Covid-19 pandemic, it’s important to weigh the pros and cons of each before taking any steps that could impact your financial future.

If you are worried about your financial health and thinking about taking advantage of the CARES Act legislation, your financial advisor can help you to better understand your options and make the best decisions for today and tomorrow.

If you’d like to talk to a financial advisor about how the CARES Act will impact your financial plan, FNBO’s team of advisors are here to help.

About the Author: Ryan is an Advisor with the Wealth Management group’s Private Client Services team at FNBO. He works with affluent and emerging-affluent clients to help them achieve their overall wealth management goals.