For retirement withdrawal needs the CARES act may seem to present a unique opportunity, but its important to watch out for potential mistakes.
The CARES Act allows: up to $100,000 in total withdrawals from retirement accounts (IRA, 401k or other tax-deferred account types) with the 10% penalty waived. In addition, there can be the ability to pay back the funds within 3 years of the distribution to eliminate the tax liability. This all may sound very tempting, but there are pitfalls to consider before moving forward.
Mistake #1: Not accounting for tax impacts
CARES provisions allow for 3 years of “paying back” your retirement accounts, as well as 3 years of spreading the tax cost . Both of these options allow for flexibility on spreading the tax bill and potentially making some (or all) of the distribution tax-free. However, you need to plan ahead on how you are planning to report, pay or potentially offset these taxes. This can become complex and involve retroactive amendments to your previous filing as well as other considerations.
What you can do: Work with your accountant as well as your advisor to set a plan around your needs.
Mistake #2: Assuming a 3 year payback on Roth conversions
The CARES laws were rushed to the presses therefore leaving some areas of uncertainty. Roth conversions are one area for you to be weary. To understand more, we have to look at the intent of the law rather than the actual “word”. The intent of the law is to allow you additional cash-flow from retirement accounts while softening the tax impact. More simply, this law is designed to allow someone in need to access money during these uncertain times.
As previously mentioned, this would allow for the withdrawal and use of the funds for any expenses with an extended “payback” or multi-year tax payment. The law is not designed or intended as a loophole for your Roth conversions. In addition to this, your tax filing necessary to denote the conversion (due to contribution limits) will inform the IRS of the action taken with those funds.
What you can do: Currently, until more explicit guidelines are provided from the IRS you should expect to pay the full tax bill for 2020. However, for conversion of shares there is a unique opportunity for you to convert more shares for a target cost during the market pullback.
Mistake #3: Taking funds simply because they are available
The temptation to take money because it is “available” at this time may be on your mind. However, remember that you’d be selling while the markets are down and creating tax costs by doing so at this time. If you move the funds now (if they’re not needed) you are taking away from your compounding future growth. What this means is that you will have less shares held at the point of a market recovery. This may not seem like much now but it can have more major impacts over time. You also need to consider the extra tax costs that you will need to pay as well. Think not only about what you’ll pay on the funds you take but what it may do to your tax bracket as well.
What you can do: Evaluate your needs and plan for the tax as well as future value impacts. Your financial planner can depict these for your consideration and review. Also, consider strategies that allow for liquidity in the future.
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