The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was signed into law by the President on Friday evening (March 27), providing the largest stimulus package in history. The historic 880-page bill provides expanded unemployment benefits, generous small business loans, cash payments to American taxpayers, and a number of other stimuli to aid individuals and businesses impacted as a result of the Coronavirus outbreak.
With a massive stimulus package thrown together this quickly and with this much money at stake, there are naturally lots of questions and financial planning opportunities.
Importantly, families in this country face cases of real economic peril caused by this pandemic (not to mention the immediate health impact to individuals who have contracted the virus). Such families and individuals are concerned with health and/or financial survival in the here and now – not how the rules for required minimum distributions (RMDs) or student loan payments will change in 2020. Moreover, individuals with multi-million dollar portfolios who face only minimal economic impact from this pandemic may not feel deserving of a $2,400 stimulus check.
The objective here is neither to opine on the “fairness” of the legislation or to tirelessly outline all the details as there are plenty of good online sources that address the frequently asked questions about the Recovery Rebate checks or the new “Coronavirus Related Distributions”. Additionally, the following does not attempt to address new strategies for small business owners resulting from the CARES Act (which may be covered in a follow-up post). Instead, this post is simply intended to describe several of the immediate and near-term financial planning strategies for individuals that arise from the CARES Act, several of which have broad impact. Lastly, for clients of Golden Bell Financial, you can expect to receive guidance if one or more of these items directly impacts you and you are encouraged to reach out if you have questions about the application of any strategy to your circumstances.
Recovery Rebates for Individuals
The stimulus checks (or direct deposits) that most of America will be receiving easy qualify as the most publicized element within the CARES Act. According to Tax Foundation estimates, roughly 94% of Americans will qualify for these “Recovery Rebates” and because the determination is entirely income-based with no asset testing, retirees with multi-million dollar portfolios will likely qualify for the full rebate check provided they don’t have large taxable income sources.
As you likely know by now, the full Recovery Rebate amount is $2,400 for a married couple filing a joint return or $1,200 for all other filers. Each child under 17 in the household adds another $500 to that rebate amount. A married couple with four children under the age of 17, for example, qualifies for a $4,400 rebate. Better still, these rebates will not be treated as taxable income.
The catch is that there is an income test which begins to reduce the full benefit at $150,000 of adjusted gross income (AGI) for married couples filing a joint return and at $75,000 for single filers ($112,500 for head of household filers). Any taxpayers with adjusted gross income above these amounts will experience $5 of reduced benefit for every additional $100 of income. As a result, a married couple with no kids will still receive some benefit provided their income is below $198,000 and a married couple with two children under 17 qualifies for benefits with income up to $218,000. There are already several online calculators if you want to calculate your family’s potential stimulus benefit.
The Recovery Rebate will initially be based on the income reported on your 2019 tax return if you have already filed or your 2018 tax return if your 2019 return has not yet been filed. Notably, there will eventually be a “true-up” as the final determination of each taxpayer’s eligibility for the stimulus will be based on 2020 adjusted gross income. If you receive only a partial rebate based on 2019 or 2018 income and then experience an income decline in 2020, you will be entitled to an increased true-up benefit once you file your 2020 tax return next year (probably long after you actually needed the benefit). Alternatively, if you receive a rebate based on 2018 or 2019 income but then report increased AGI in 2020 which qualifies you for a lower benefit than you actually received, you will not be subject to any “claw-back” of the Recovery Rebate received this year.
To be clear, these Rebates were designed to help people in need during a time of crisis. And that will be true for many Americans. But consider the individual taxpayer with no children who reported $100,000 of adjusted gross income on his already-filed 2019 tax return and then lost his job in early 2020 due to the Coronavirus epidemic. This taxpayer will not immediately qualify for a rebate check because his 2019 income exceeds the qualification threshold. Only this time next year, once he files his 2020 return in early 2021 and reports minimal 2020 income, will he qualify for a rebate check.
Aside from wanting to know if they qualify for the stimulus checks, the other popular questions being asked right now are when and how the stimulus checks will be sent. According to Treasury Secretary Mnuchin, the first payments are supposed to be sent the week of April 6. Based on staffing shortages at the IRS, experts believe this is an ambitious timetable and it may take several more weeks beyond this before the checks start going out.
If you are entitled to a Recovery Rebate, the IRS will use the direct deposit information on your most recently filed tax return (2019 or 2018) and issue your rebate using those instructions. If you have not provided direct deposit instructions to the IRS, you will receive a mailed rebate check.
Let’s now consider a few planning implications stemming from all these details based on your circumstances.
Your adjusted gross income in 2019 was lower than in 2018. If you a) will qualify for a rebate; and b) you will report lower income in 2019 than in 2018 (perhaps because you retired in 2018 or 2019), you should plan to file your 2019 tax return immediately, if not already filed. Unless you qualify for the maximum benefit using either 2018 or 2019 income, it is going to be advantageous to file immediately as the lower 2019 income will qualify you for a higher benefit amount.
You have a child who turned 17 in 2019. If you a) will qualify for a rebate; and b) you had a child who turned 17 in 2019, you may want to wait to delay filing your 2019 tax return, if not already filed. It is still unclear how the IRS will treat a child who turned 17 in 2019 but, while there is uncertainty, it won’t hurt to use the 2018 return – unless your 2019 income is markedly lower than 2018.
You are married and don’t qualify for a stimulus check based on your joint income but the lower earning spouse has income under $75,000 and would qualify based on his/her income. Depending on other circumstances, it may make sense to immediately file separate tax returns for 2019 where one spouse is able to qualify for the Rebate Recovery check (and again depending on circumstances, treat any children under age 17 as dependents of the lower earning spouse). If you are not in immediate need of the stimulus, you could simply consider filing separate tax returns at this time next year.
Relaxation of IRA and Retirement Plan Distribution Rules in 2020
To provide financial relief to individuals impacted by the Coronavirus pandemic, the CARES Act draws on legislation utilized during the financial crisis, allowing individuals to take hardship distributions of up to $100,000 from a 401(k), IRA, or other qualified retirement account without the standard 10% early withdrawal penalty for individuals under 59.5 years old. The qualifications to utilize this provision are broad and include anyone:
- who is diagnosed with COVID-19;
- whose spouse or dependent is diagnosed with COVID-19; or
- who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, being unable to work due to lack of child care due to COVID-19, closing or reducing hours of a business owned or operated by the individual due to COVID-19, or other factors as determined by the Treasury Secretary.
The liberal definition of item three means that most working Americans will qualify for this relief.
In addition to the suspension of pre-59.5 penalties for retirement plan distributions, there are some other attractive benefits of these “Coronavirus-Related Distributions”: no mandatory withholding on the distribution; the distribution can be repaid over three years; and the taxation of any distributions can be spread evenly over three tax years (2020, 2021, and 2022).
While prematurely distributing from retirement accounts is generally discouraged, the Coronavirus-Related Distributions provide a viable liquidity option for anyone struggling to pay bills due to loss of income or other financial hardship. Even for those not in need of a retirement account distribution to pay the bills right now, there are some planning opportunities to consider:
Use Coronavirus Related Distributions to Take Advantage of a 401(k) Match. It appears likely that many employees will pause 401(k) or 403(b) plan contributions (or have already paused the contributions) in light of wage uncertainty related to COVID-19. If you are in this situation and giving up some or all of an employer match by pausing retirement plan contributions, an alternative strategy would be to continue contributing to your employer’s plan and use a Coronavirus-Related Distribution to offset the 401(k)/403(b) deferral amount – creating a cash flow neutral payout but gaining the employer match.
Consider the situation where your employer matches 50% of your 401k contributions up to the first $10,000 of deferrals. Rather than pausing deferrals and losing this match, you would be wise to continue deferring the $10,000 for the remainder of 2020 while simultaneously withdrawing $10,000 from an existing retirement account as a Coronavirus-Related Distribution. From a cashflow perspective and a retirement savings perspective, it is a net wash because you are effectively moving money from left pocket to right. Except, there are three benefits:
- You qualify for the employer match of $5,000 which would have been lost had you stopped making contributions.
- You get the immediate benefit of the $10,000 tax deduction to the retirement plan whereas the offsetting tax liability from the $10,000 distribution can be spread over three years with the last 1/3 not due until sometime in early 2023.
- You can elect to put the $10,000 back in your retirement account at a later date, within three years from the time of distribution, should your financial conditions improve.
Notably, since these distributions are available for the remainder of the calendar year, there’s no urgency to immediately distributing the funds. In fact, since the optional three-year payback clock starts at the time of the distribution, it is better for anyone using the Coronavirus Related Distributions to only draw funds as needed rather than all at once, thereby extending the 3-year payback window by several months.
Use Coronovirus Related Distributions to Reduce 2020 Income and Qualify for a Larger Recovery Rebate Check. Similar to the preceding strategy, the idea here is for anyone who won’t qualify for a stimulus check based on 2018 or 2019 income but who might qualify based on lower income this year to reduce adjusted gross income enough in 2020 via 401(k), IRA, or HSA contributions to qualify for a partial or full rebate amount.
For example, consider a married couple with three children where one spouse works but $250,000 of income in 2018 and 2019 disqualifies them from an immediate stimulus check. Due to the Coronavirus pandemic, they expect adjusted gross income to decline to $182,000 in 2020 and have elected to halt all retirement plan contributions this year. Rather than suspending their retirement plan contributions, the working spouse could contribute $19,000 in pre-tax deferrals to her workplace plan, the husband could contribute $6,000 to his IRA (since he qualifies to do so based on his spouse’s income), and they could make $7,000 of contributions to their health savings account (assuming they are eligible), thereby reducing adjusted gross income by $32,000.
Lowering income from $182,000 to $150,000 in 2020 qualifies them for the full $3,900 stimulus payment – an additional $1,500 beyond what they would have received without these contributions. To make up for the lost cash flow, they can simply withdraw $32,000 from their existing retirement account balances as Coronavirus Related Distributions (and there’s nothing to keep them from simply withdrawing the IRA and 401(k) contributions minutes after they are made). Again, they even have the option to repay these distributions over the next three years should their financial conditions allow.
Use Coronavirus Related Distributions to Make 2019 IRA Contributions. Consider a married couple who was eligible to make IRA contributions in 2019 ($6,000 each) but did not have liquid funds in order to do so. This couple could (at any point until the extended July 15 tax deadline) withdraw $12,000 from their existing retirement accounts (in any combination – it could all come from one account) as a Coronavirus Related Distribution and immediately use the funds to make tax-deductible (or Roth) contributions to their IRA accounts for the 2019 tax year. If they elect to make Traditional IRA contributions, they reduce 2019 taxable income by $12,000, thereby resulting in less taxes than would have otherwise been owed. Moreover, taxes on the distribution can be split between payments in 2021, 2022, and 2023 or avoided entirely.
Required Minimum Distribution (RMD) Waived for 2020
The CARES Act suspends required minimum distributions (RMDs) for 2020, providing broad relief to include IRAs, 401(k)’s, 403(b)’s, 457(b)’s, and even inherited retirement accounts. The suspension applies to any distribution that was required in 2020 – even for individuals who turned 70.5 in 2019 and used the special first year election to defer their RMD into 2020. This is obviously welcome news – especially for retirement account owners who live off of other income sources or assets and generally do not need the required distribution.
Let’s run through the different scenarios and outline what is likely to be the optimal strategy for each scenario.
You faced a required minimum distribution (RMD) for 2020 but have not yet taken the distribution. For individuals who fit this case and are still working (perhaps with an inherited IRA) or who otherwise expect to have high income in 2020, it is generally advisable to use the opportunity to skip the distribution this year.
You faced a required minimum distribution (RMD) for 2020 and already completed some or all of the distribution since the start of the year. Provided that you have other sources of income or other assets from which to fund living expenses, you should plan to quickly replace the previously distributed amount. There are a few exceptions or limitations noted below.
- Non-spouse beneficiaries of an inherited retirement account who have already fulfilled the 2020 RMD from the inherited account cannot reverse the RMD and get the funds back in the account.
- In situations where more than 60 days have passed since funds were distributed from a retirement account, the funds can only be replaced if the owner meets the liberally defined “Coronavirus Related Distribution” rules outlined above. Anyone who fulfills this condition (and it is self-certification) will be able to replace an already distributed RMD, even if more than 60 days have passed since the distribution.
You faced a required minimum distribution (RMD) for 2020, are retired, and have other sources of income or other assets from which to fund living expenses. If you will experience a one-year reduction in taxable income during 2020 due to the RMD suspension, it would be financially wise to consider a 2020 Roth conversion in lieu of the RMD to take advantage of the temporarily lower tax brackets.
You faced a required minimum distribution (RMD) for 2020, will likely use the standard deduction, are over age 70.5, and intend to make charitable contributions during the year. Even thought the RMD has been suspended in 2020, qualified charitable distributions (QCD) are still permitted. Moreover, the QCD still provides a significant tax benefit for anyone over age 70.5 who desires to make charitable gifts so the suspended RMD rules do not mean you should suspend use of QCDs.
Closing Comments
Obviously, there are a lot of important financial and tax planning changes stemming from the CARES Act. It took more than 2,700 words to outline just three elements of the Act and that’s without covering the important changes for small businesses, unemployment benefits, or even significant changes relating to student loans and charitable giving for individuals.
We hope to add more color in the coming days on some of these other items but, in the meantime, questions, comments, or suggestions are welcome.