COVID did a number on business finances, which seep into personal finances. Most of us have heard about the $600 unemployment bump and the $1200 stimulus checks meant to help individuals. Even if we are not feeling distress, we should be aware of all the options available to us to improve our financial situations.
Since the 2019 filing date for taxes was extended until July 15th, it was only fitting that IRA contribution dates moved as well. If you are one who does not consistently take advantage of these full annual contributions and you have some cash on hand to invest, your curiosity should be peaked.
We have never had so much time to make contribution decisions for 2019. We now have over half of 2020 to glean what our best tax situation will be for both years. You have the power of choice, especially if your cash is limited.
- In 2019, the maximum amount you can contribute to a Traditional IRA is $6,000 if you are younger than age 50. Workers age 50 and older can add an extra $1,000 per year as a “catch-up” contribution, bringing the maximum amount to $7,000.
- The contribution limits are the same for 2020.
There are phase-outs to the deductibility of IRA’s for high earners. When in doubt, check with your accountant and compare which tax year to best invest your money, 2019 or 2020? Even if you filed your 2019 return, you can still amend it.
Let’s not forget the ROTH IRA option. Given the current stock market, many are hedging that this is a great time to buy. If you are optimistic for a grand increase then an investment now of your taxed dollars for tax-free growth and withdrawals down the road could be a considerable advantage. Once again, check with your accountant to compare income limits and tax consequences of ROTH IRA contributions. The 2019 contribution extension applies to ROTH IRA’s as well.
Retirement Account Withdrawals
We covered the depositing side of retirement accounts. Now we will discuss withdrawal options.
For many PPP has not been enough to save them from hardship and they are having to access other personal assets. Normally retirement accounts become a last resort when we are not yet retirement age. The CARES Act created a loophole to avoid penalty.
Within certain IRS permissions and justifications, if you have been financially impacted by COVID-19, whether you experienced personal sickness, a spouse or dependents who were sick, adverse financial conditions such as closing your business, or a decrease or loss of personal pay, then new rules apply to withdrawals.
You are allowed to withdraw up to $100,000 in any combination of IRAs or employer-sponsored plans providing the plan is setup to deliver on the new CARES Act provision.
For those not yet 59 ½ the 10 percent penalty that generally applies is waived.
The amount withdrawn in 2020 is taxed but can be spread out among your next three years tax returns. For example, if you withdraw $30,000, you will only pay income tax on $10,000 in 2020 and repeat that again for 2021 and 2022’s returns. Additionally, if you pay back these retirement accounts in the next three years, that tax liability can be eliminated, even going back to 2020 with an amended return.
Borrowing from a 401k
You can borrow 100% of your vested interest up to $100,000 from a 401k. (not an option with IRA’s, sorry!)
- Previously this loan amount was capped at $50,000 with and 50% of vested interest.
- Loan payments that were due March 27th through December 31st, 2020 are also delayed.
For any withdrawals on your retirement account, it is a prudent idea to contact your accountant first to help run tax-planning scenarios. It is also wise to talk with your financial advisor on the drawbacks a withdrawal now could have on your long-term retirement plans.
Required Minimum Distributions
Those who are 72+ or inherited certain retirement accounts and are obligated to withdraw annually as a Required Minimum Distribution (RMD). The CARES Act has suspended required minimum distributions in 2020 for IRAs and 401(k) retirement type accounts (but not defined benefit plans) and some inherited plans. Of course, you are still allowed to withdraw if you need the funds, but for those who do not you will want to consider your next best tax move.
Your 2020 RMD calculation comes from the account valued as of December 31st, 2019. If that value is tied to the stock market, your RMD was likely figured much higher as a percentage of the current value of the account today.
A key strategy for tax management is often to defer income for as long as possible. Not taking your 2020 RMD can be an attractive opportunity to avoid earnings and allow the account to grow and recover.
However, before you decide, consider what you expect to earn in 2020. Will it be less than future years? If so, this may be an ideal year to withdraw when your tax rate is lower and reduce your RMD’s in future years.
If you have already taken an RMD before learning of this new option, some types of account withdrawals are allowing an extended window to return it before July 15, 2020. Check with your financial advisor on facilitating that movement.
Employee Benefit Elections
Speaking of options, it is time to check with your employer on your benefit elections. The CARES Act opened up the election period to allow changes to select benefit elections such as Flexible Spending accounts and other contributions. It is not often we get this chance mid-year; it’s like being given half of a crystal ball.
And don’t forget that your Health Savings Account dollars have also been expanded to include more of your over the counter purchases. See our article here.
While 2020 has brought a number of new challenges, we hope that your household will find opportunities to flourish financially.