Next steps for investors who withdrew funds under the CARES Act

Next steps for investors who withdrew funds under the CARES Act

In addition to direct aid to households in 2020, the CARES Act pandemic relief bill offered some temporary provisions to help individuals and families manage economic hardship as a result of the pandemic.

Millions of people lost their jobs due to restrictions placed on work and travel in efforts to contain the Covid-19 virus early in 2020. Many savers had to take money from retirement and savings accounts to pay bills. In the first three quarters of the year, roughly 5% of 401(k) participants took Covid-related withdrawals to help with daily expenses. (Investment Company Institute).

The CARES Act allowed eligible individuals to withdraw up to $100,000 in emergency funds from retirement accounts without penalty. Typically, an early withdrawal would result in a 10% penalty. The funds helped thousands of families cover bills and expenses during challenging times. Still, these pandemic “distributions” are considered income, and many taxpayers preparing for tax season are realizing that this money is taxable.

To qualify for the penalty-free withdrawals, individuals had to meet certain criteria outlined by the Internal Revenue Service. Individuals, or a spouse or dependent, had to be diagnosed with Covid-19. They also had to experience certain financial impacts or economic hardship such as being quarantined, furloughed or laid off, or having to work reduced hours. Additional criteria also included having a job offer rescinded or a start date delayed. For more details on the program, read the IRS article.

While taxes are due, investors have options for paying. They can also re-pay the funds to a retirement account, according to the IRS rules.

Tax-filing season brings choices

  • Distributions from pretax accounts are included as income and reported ratably over a three-year period. Taxpayers report one third of the distribution on their 2020 tax return, one third in 2021, and one third in 2022
  • Alternatively, taxpayers have the option of reporting all of the income on the 2020 tax return instead of spreading it equally over three years
  • Taxpayers should consult with their tax professional on what makes more sense based on their personal circumstances
  • While many taxpayers will prefer to spread the income tax liability over the three-year period, some may find that accelerating income into 2020 may be more beneficial, if they are in a lower tax bracket in 2020 than expected going forward
  • Taxpayers who requested a qualified Covid-19 distribution must include IRS Form 8915-E (Qualified 2020 Disaster Retirement Plan Distributions and Repayments) with their return. To obtain the form, visit the IRS site.

The distribution can always be re-paid

  • Repayment must occur within three years of the Covid-19 distribution and does not have to go into the same account, as long as the investor uses an eligible retirement account
  • For example, a plan participant with a qualified Covid-19 distribution taken from their 401(k) could return those funds to an IRA in their name
  • Depending on the repayment, amended tax returns may be required to claim a refund of the tax attributable to the distribution
  • The repayment amount can be equal to the total Covid-19 distribution, or less

Check with a tax expert

Investors should check with a professional tax preparer or their financial advisor before deciding how to include the distribution in their upcoming tax filing.


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