How to Pay Off the Retirement Spread of the Coronavirus
When the CARES Act was passed at the end of March, it provided a lifeline for people facing financial constraints due to the coronavirus pandemic: the ability to receive payments on bills without penalties for early retirement .
While we initially cautioned against this step, unless you really find yourself in a difficult situation, the number of questions about the withdrawal process – and ultimately, their refund – indicates that many people have already considered their options for accessing cash and decided that retirement was their best option.
If you belong to this group, you might be wondering what you will do after you withdraw funds from your tax-free retirement account, such as 401 (k). Let’s take a look at some general questions about managing the next steps after early distribution.
How do I get my distribution money back?
You will repay your distribution with a carry-over contribution to the same account from which you borrowed the money.
If you take more than one distribution (say you take $ 10,000 and then another $ 15,000), you have a different three-year time frame for each of these distributions.
What about taxes? How do I pay them?
Look for IRS Form 8915-E towards the end of the year – you will use it to report any coronavirus-related payments on your 2020 tax return. If you use an online service to file your tax return, they will probably be able to walk you through the fields on this form in the same way you would fill out the rest of your tax return.
Typically, you have two options for paying taxes on any money you withdraw from your retirement account: you can divide it by three years, or you can count it all as income for that year.
Here’s an example the IRS gives: “If you get a coronavirus-related spread of $ 9,000 in 2020, you must report income of $ 3,000 on your federal tax returns for 2020, 2021, and 2022.”
Why would you choose one option over the other? It depends on your money plan.
If you intend to accept a withdrawal as temporary, you do not need to pay all income tax on that amount right away. But suppose you know you need this money from your retirement account, and you don’t know if you can pay it off in a three-year window. In your case, you can choose which income tax plan is best for you.
Here’s another snag in this whole thing, from another IRS example : Let’s say you pay distribution tax for three years, but in the third year you can pay the distribution amount in a lump sum. You will not need to pay income tax for the last year of distribution, but in order to claim a refund of income tax already paid, you will need to file an amended tax return for the first two years.
Can the company’s contributions be applied for repayment?
Since your payment must be made as a rollover installment, the only funds you can use for this repayment are your own.
If money is regularly deducted from your paycheck for transfer to an employer-sponsored retirement account, this will not count towards your repayment. You will need to either suspend your regular contributions until you catch up with your rollover contribution (which could mean you miss out on an employer match ), or pay in your regular contributions plus your rollover contribution.
What if I can only repay part of the balance before three years?
If you pay back only a portion of the amount, you will only be on the hook to pay taxes on the remainder of the amount that you did not pay. But you may still need to file an amended tax return to reflect the correct amount that you will ultimately save.
The nuances of the coronavirus-related spread, plus guidance that the IRS has yet to provide, underscore the importance of thinking about this decision before you start extracting money from your retirement savings.
While this may be your best bet for accessing cash during difficult times, it is not an easy decision. And it is probably best to discuss this with a financial advisor before making the final call.