Borrowing from Retirement Savings under CARES Act
Concerned about your financial future due to the COVID-19 Crisis? John Mills of Tax Centers of Georgia told members of the GABB about ways you can borrow from your retirement savings without penalty and other tax strategies.
As the COVID-19 virus wreaks havoc on our personal life and financial markets, Mills discussed little known strategies to help businesses and individuals negotiate current financial hardships. The Georgia Association of Business Brokers (GABB) is hosting weekly meetings to answer members’ questions during this pandemic.
A recording of the presentation is linked here.
Mr. Mills, a partner in Tax Centers of Georgia, said that the CARES Act provides an unusual opportunity to get access to your 401k or IRA investments without age restrictions or penalties.
He said many tax experts think “average” income earners could be paying as much as 37-54% in taxes in the near future. He discussed how and investor could add hundreds of thousands dollars of tax-free cash flow to retirement income without any additional savings.
Under the CARES Act, who can get money out of a 401k and/or IRA? Anyone:
- Who is diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention.
- Whose spouse is dependent (generally a qualifying child or relative who receives more than half of his or her support from you) is diagnosed with COVID-19 by such a test.
- Who experiences adverse financial consequences as a result of quarantine, furlough, layoff, or having work hours reduced due to COVID-19.
- Who is unable to work because of lack of child care due to COVID-19 and experiences adverse financial consequences as a result.
- Who owns or operates a business that has closed or had operating hours reduced due to COVID-19 and has experienced adverse financial consequences as a result.
- Who has experienced adverse financial consequences due to other COVID-19 related factors to be specified in future IRS guidance.
COVID-19 401k/IRA Plan Details
- Loans will move from 50% or $50,000 to 100% or $100,000 that you can borrow. This options ends on September 23rd. Your plans loan rates can vary from other plans. You then pay back the loan over 5 years (this can be done with payroll deduction and dramatically increase your savings above the IRS rules).
- If you qualify (based on COVID-19 rules) you can withdraw up to $100,000. You will not be subject to the IRS under 59 ½ rule requiring a 10% penalty. End date for this is 12/31.
- If taken as a distribution, taxes owed can be spread over three years or you can choose to pay the taxes lump sum at the end of three years and skip the tax now.
- This is a one-time opportunity, Mills said.
Option #1: Loan
- Take up to a $100,000 loan from your 401k plan or any other lesser amount.
- Pay back the loan through payroll deduction over 5 years or, in a lump sum at the end of five years. Be your own bank! If you can afford more than the $20,000 limit of your normal contribution, you can now deposit $40,000 per year into your 401(k) (normal contribution plus loan each year.
- Your interest rate may be PRIME (currently about 3.25%). Each plan can vary on the rate, but rates are at an all time low.
- You now have $100,000 in your hands, income tax free.
- Just because you could take a loan, doesn’t mean you should, Mills advised.
Option #2: Distribution
- Take” the full $100,000 as a distribution from your 401k or IRA
- This could be the only time in your lifetime that you can get money out of your pre-tax account while under 59 ½ without a 10% penalty.
- The tax can be spread over three years (Due April 2021, 2022 and 2023)
- Assuming a 24% tax rate, that would mean only $8,000 in tax each year. This can be paid from savings or any other non-qualified investment you may have. If pay in 4 installments (1 immediate and 3 more over 2021-23) it would mean 4 installments of only $6,000.
- How does that benefit you to pay these small taxes over 3 years?
Alternative #1: Roth Conversions
- There is no limit on the amount you can convert from IRA or 401K to Roth
- The CARES ACT however limits the amount you can draw out of your IRA or 401k without the 10% penalty ($100,000 “per person”)
- The Roth will still have the 10% penalty before age 59 ½ and even if over that age you must hold the Roth for 5 years before accessing any of the money.
- Depending on where you invest the Roth money (Stocks, Bonds, Mutual Fds etc.) you still carry all the risk as you did in the 401(k).
What else can you do with the money?
- What if we could get the money to grow tax-deferred (the $100,000) and have it come out 100% Tax-FREE (like the Roth)?
- What if you passed away prematurely and your family then received a large sum, potentially 3 times the amount of money you took out, again…100% Tax-FREE?
- What if you had a chronic illness or required a Long-Term Care stay and you could have money to help cover your stay…100% TAX-FREE?
- What if you had a short-term financial need and you could access this same money again without any 10% governmental penalty or tax BEFORE age 59 ½ ?
Can I really do that?… YES
- Borrow OR take your distribution (or any part of the maximum) and place it in a 7702 plan using life insurance vehicles. Immediate potential benefit for your family should you pass of $336,000*
- Cash then grows tax-deferred and comes out tax free for your retirement or whenever you might need it **.
- Take your tax-free income for 10, 20 years or possibly longer in retirement.
- Receive proceeds in case of a chronic illness or Long-term care need…TAX-FREE.
- Cover a college education or wedding…TAX-FREE.
To find out more, Mills invites businesses and individuals to contact him.
Linked below is Mr. Mills’ PowerPoint presentation.
Cares Act Pwpt- .John Mills (1)-1