Who Qualifies for a CARES Act Distribution?

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Ernie Guerriero, CLU®,ChFC®,CEBS,CPCU®,CPC®,CMS,AIF®,RICP®,CPFA

Over the last several weeks I have spoken with producers who are working with their clients helping them through financial difficulties during this pandemic. One area where there are funds to access is in the employer sponsored retirement plan, usually in the 401(k). As you are aware the Coronavirus Aid, Relief and Economic Security (CARES) Act allows distributions up to $100,000 through the end of the year, but they are not mandatory. Employers (the Plan Sponsor) of these retirement plans (also 403(b) plans and governmental 457(b) plans, and IRAs, Defined Benefit Plans may not make these distribution unless the participant is at least age 59 1/2) may or may not offer this type of distribution.

However, if a plan allows for this CARES Act distribution, only participants who are “qualifying individuals” who have been affected by COVID-19 will be eligible to receive them. Who is eligible?

Under the CARES Act and later expanded by IRS Notice 2020-50, distributions are available to individuals if they or their spouse or tax dependent has been diagnosed with COVID-19 using a test approved by the Centers for Disease Control and Prevention (CDC) or if they have experienced COVID-19-related adverse financial consequences as a result of being quarantined, furloughed or laid off or having work hours reduced, or as a result of being unable to work due to lack of child care, or the closing or cutback in hours of a business owned or run by them. CARES Act distributions may not be made if the spouse or dependent rather than the participant suffers the adverse financial consequences. In that event, the spouse would have to qualify under the spouse’s plan. The individual would need to self-certify that they have satisfied the requirements to receive CARES Act distributions.

If and “eligible” individual self certifies that they qualify for the distribution they would be subject to reduced Federal tax treatment. These Distributions Get Special Federal Tax Treatment. CARES Act distributions are not treated as qualifying rollover distributions, so are not subject to mandatory 20% withholding, and they are also exempt from the 10% tax on distributions paid prior to age 59 ½ (with the exception of Defined Benefit Plans as mention above). Unlike regular distributions, which are taxable in the year of distribution to the extent they are not rolled over, Federal tax liability for CARES Act distributions may be spread over the three-year period from 2020 to 2022. There is also a special right to recontribute all or part of a CARES Act distribution within three years of the date of the distribution to an eligible plan that accepts rollovers. This eliminates federal tax on the recontributed distribution. Any distribution made to a qualified individual in 2020, even if it was made before the CARES Act was passed, may be designated as a CARES Act distribution by a qualified individual. It does not matter whether the plan specifically provides for CARES Act distributions and, in order to qualify, the qualified individual doesn’t have to provide proof of a specific loss caused by COVID-19. However, the total designated by a qualified individual for special tax treatment may not exceed $100,000.

A caution is in order. Although the individual receives special Federal tax treatment States may treat these distributions differently. For example, under the CARES Act Federal tax law allows individuals a three-year period to rollover distributions from retirement plans (up to $100,000), for NY State and NY City purposes, the distribution would need to be paid back within 60 days to avoid taxation.

Individuals need to consider distributions under the CARES Act along with any alternatives. They must especially consider any other consequences and/or restrictions imposed by their State. Any decision should be made with the tax and legal counsel before making this important decision.

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