401(k) Options in COVID-19 Pandemic

June 10, 2020

Many of us are currently unemployed and possibly will not have the opportunity for continued employment for the remainder of 2020.  With the passing of the CARES Act signed into law March 27, 2020, we have choices and opportunities with our retirement accounts.  These include the following:

  1. Waiver of required minimum distribution.
  2. Qualified participants can borrow enhanced loans up to $100,000.
  3. Vested account balances can borrow up to 100%. (This compares to the old law of 50%.)
  4. Waiver of 10% penalty tax (typical 10%) and waiver of 20% federal tax withholdings.

If participants do take a distribution from the plan, you can repay the amounts distributed and recover and avoid paying taxes on these funds.  401(k) participants will have three years beginning on the day after the distribution to repay or roll back funds.  Two very important facts:

  1. You have to be impacted by COVID-19 to be eligible.
  2. Some employer-sponsored retirement plans may not offer these exceptions.

If you are leaving your job

A plan participant leaving an employer typically has four options (and may engage in a combination of these options), each choice offering advantages and disadvantages. The options are as follows:

  • Leave the money in his/her former employer’s plan, if permitted;
  • Roll over the assets to his/her new employer’s plan, if one is available and rollovers are permitted;
  • Roll over to an IRA; or
  • Cash out the account value.

Roth IRA Conversion

Should your income for 2020 be relatively low compared to the prior years and future years, you may want to consider converting retirement funds to Roth IRAs. Although you will have to pay tax on this conversion, you may have a very low tax bill compared to other years should you convert.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future contributions to a Roth IRA. In addition, if you are required to take a required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.

I have outlined very broad tax-related issues and opportunities. Be sure to seek professional tax advice before you initiate any transaction.