Several of the relief measures can provide significant peace of mind, as they provide you with the option to access some of the funds in your retirement accounts without the usual penalties if you have been negatively affected by COVID-19.
Deferred RMDs, 5-Year Rule and 401K Loans
In response to the economic fallout stemming from the pandemic, Congress passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which relaxes some of the rules governing your retirement account (e.g., TSP or 401K). For example, if you are younger and COVID has adversely affected you, a key relief measure permits you to withdraw some of the funds in the account without the usual penalties. If you are older AND are (or would be) subject to take required minimum distributions (RMDs), you may defer your distributions this year, which relieves you from the requirement to withdraw money for the sole purpose of paying taxes. Below we explain more fully the changes made to defer RMDs and then changes made to take early distributions and loans due to COVID-related circumstances.
If you have a retirement account such as a 401(k), 403(a) or (b) plan, a 457, or an IRA (not a defined benefit plan), the CARES Act waives RMDs for the calendar year 2020, meaning that if you do not need the distribution, you can leave the funds in your account, avoiding any income tax that would be due if you took a distribution. (Remember, due to the SECURE Act changes, effective January 1, 2020, the law requires account owners typically to take an RMD from their plan upon reaching age 72.)
Provision may lower your tax bill for 2020
70 ½ Deferral
The CARES Act waiver also applies to RMDs for account owners. who reached age 70 ½ in 2019 but deferred taking an RMD in 2019 until April 1, 2020. Normally, account owners in this category would also have to take a second RMD for 2020 by December 31, 2020, but this RMD is waived as well.
Inherited Retirement Accounts
If you have an inherited retirement account – as a “designated beneficiary” then you too may defer taking your RMDs. You may be a designated beneficiary even if the account pays to a trust provided that the trust contains “conduit” provisions permitting the trust to be regarded as a “see through” trust.
When the retirement plan is paid to a trust that does not qualify as a “see through” trust, then in these circumstances the CARES Act adjusts how the “five-year” rule is counted. The five-year rule requires an inherited account to payout within five years of the death if the plan participant dies before age 72 in 2020. So year 2020 will simply not be counted for the purpose of the calculating the five-year rule.
10-Year Payout Rule
The CARES Act has no effect on the 10-Year Payout Rule. As a result of the SECURE Act, the practice of “stretching-out” distribution payments of an inherited retirement account by including the lifespan of the recipient beneficiary in the payout schedule has been curbed for most non-spousal beneficiaries. (Generally, an “inherited retirement account” does not include transfers to the surviving spouse as they are considered instead to be “roll-overs”). Under this 10-year rule, the inherited retirement account must be paid out within ten years, and the 10-year clock begins to run the year immediately after the year that the account owner dies. So applying the 10-year payout rule to deaths occurring 2020, the events of 2020 are simply outside the relevant period for counting the 10 years as the first year will be 2021. This of course could change if Congress provides relief for the 2021 too.
Early Distributions without Penalty
Under the CARES Act, the 10% early distribution penalty tax that would otherwise apply to the majority of distributions made before a participant turns age 59 ½ is waived for “coronavirus-related distributions” (CRD) made at any time during 2020 from qualified retirement plans for distributions of up to $100,000.
CRD is a distribution from an eligible retirement plan made during 2020 to a qualifying individual
The distributions will be subject to income tax, but if you qualify, you may opt to spread the payments evenly over three years rather than having to pay it all in 2020.
You may also recontribute the distributed funds to the retirement plan or another retirement plan (with an exception for 457 plan distributions), by a single rollover or multiple rollovers, within three years of the date of the distribution regardless of any contribution limit established by the plan.
401K Loan Payments
Qualified individuals with an existing loan from a retirement plan that is due to be repaid by December 31, 2020, can delay repayment by one year. Later repayments will be adjusted to reflect the delayed due date plus interest accruing during the delay. The one-year period of delay in repayment is disregarded in determining the maximum five-year loan period.
We often think of retirement accounts as monolithic resources. It is easy to see why – we spend our working years socking away money for our future. Unfortunately, though, the rising cost of healthcare can quickly deplete even the largest of retirement funds. Because retirement accounts tend to be the largest assets in a person’s estate, it is crucial that proper planning is done to handle one’s retirement fund.
The first thing you need to do is ensure you have the assets you need to take care of yourself and your family. With the increased costs of healthcare, it is crucial you have what you need after you retire and can manage your medical expenses on a fixed income. While we would all hope for a quiet retirement, finances can be unexpectedly stressful. In addition to budgeting out a financial strategy to keep you comfortable during retirement, we can also work with your financial advisor to help you develop a strategy for distributing any leftover funds upon your death.
In addition, the rules surrounding the taxation of retirement accounts can be difficult to understand, further complicating a potentially stressful retirement experience. Upon retiring, you will have to take a required minimum distribution, which will be subject to income tax. Most people are used to having income tax withheld from their paychecks, but sometimes overlook that they will still have a similar tax liability for their retirement account.
It is also important that your strategy for passing on the account takes into consideration the tax consequences. As mentioned above, because these accounts are created with pre-tax contributions, the required minimum distributions made to the owner are subject to income tax. When these funds are distributed to a designated beneficiary after the owner’s death, there are still income tax concerns regardless of who is named as the designated beneficiary. It’s why working with a trusted financial advisor and attorney is so important to enjoying your golden years. With these experts on your side, you’ll rest easy knowing you’ve taken care of your family in the present and future.
Ultimately, you will benefit most from ensuring your retirement plan and estate plan align. By working with your trusted financial advisor and us, you can ensure the goals you have for your retirement and for your estate do not contradict one another. For example, you may have designated one beneficiary for your account when you signed up for your 401k but may now wish to change who or how the beneficiary will receive your assets upon your death. Or, you may have originally anticipated the excess funds from your retirement account being used to care for an aging loved one, but due to the market, you may need to find additional sources to cover these anticipated expenses. Meeting with your financial advisor and us is crucial to making sure your family and loved ones are not stuck in financial hardship after you have passed.
When it comes to retirement, it can be difficult to know what you do not know. If you are concerned about the state of your retirement account, assets and estate plan, schedule a meeting with your financial advisor and us today. With so much on the line, it pays to do your homework, connect with professionals and ensure your final wishes are documented and respected.
Receiving an inheritance is a huge blessing but, if not handled properly, can also become a curse. Often times, the inheritor does not know what to do with the new asset and runs into financial trouble, squandering most, if not all of it. This could happen due to the inheritor having outstanding creditor issues or tax troubles or being inexperienced with managing the new assets. No matter what the financial obstacles maybe, estate planning can help address or even eliminate these issues. For these reasons, it is vital to update your estate plan - or create one if you have not already - if you have received or are expecting to receive an inheritance.
How Inheritances Affect Estate Plans
An inheritance will likely change your assets in a major way, which may result in a change in your tax and financial planning needs. An inheritance may also increase your exposure to lawsuits since people are more likely to seek out the “deep pockets” in a lawsuit. If your inheritance is the first time you have invested or have had substantial assets, an estate plan can set up safeguards to both manage and protect your wealth. If you already have an estate plan in place, it is critical to update it so that the plan incorporates your recent inheritance. The presence of more assets may require a revision in order to make sure that your intentions are properly carried out. This is particularly true if you have a blended family, have changed from a non-taxable to a taxable estate because the value of your assets is now over $5.6 million for D.C. residents ($11 million federally), or if your original estate plans involved utilizing a charitable strategy. Putting your inheritance to work - whether it be for short-term or long-term financial goals - will help you avoid wasting your inheritance.
Preserving Your Family’s Wealth
Another important reason to re-evaluate your estate planning when you receive an inheritance is to preserve your family’s wealth. Unfortunately, statistics on wealth preservation across generations are grim. Studies estimate that 70 percent of wealthy families lose their wealth by the second generation, and 90 percent lose it by the third. One common reason for these surprising statistics is the lack of communication among generations. Needless to say, proactive steps are necessary to preserve wealth for the long-term. Families fail to discuss this important topic because money can be a taboo topic to discuss openly, the older generations fear that the younger generations will become lazy and entitled if they are made aware of their inheritance too soon, or they fear their private financial information will be leaked to those who should not have the information. But, if your family is open, honest, and everyone plans properly, your family does not have to see its collective fortune evaporate within a couple generations. Estate planning can provide the foundation to ensure assets continue to be managed properly and are preserved instead of dissipated. Proper planning can also make wealth a part of the family legacy instead of a burden or societal ill
Seek Professional Advice
An inheritance can be used up faster than you would think, but proper planning can reduce this risk. If you have received an inheritance - or expect to receive one in the near future - it is vital that you seek out financial and legal advice. Give us a call to schedule an appointment so we can discuss your options to help preserve your family legacy.