Affected by COVID-19? Withdraw from your retirement early and save $10,000 in taxes.
Need a letter to your plan administrator explaining that you were affected by COVID 19 and need to withdraw retirement funds? Click Here
Want to read the IRS circular on this topic yourself? Click Here
Hi, I’m Dan
And I’m Brooke with the high yield real estate investing podcast.
As we write and record this, it’s the beginning of August 2020. We’re still in the middle of the coronavirus pandemic so Congress is trying everything they can to keep the economy and stock market from completely tanking. In response to shutting down much of the economy in March, Congress passed the CARES act which distributed stimulus checks, federal unemployment to individuals, and additional financial measures. The part of the CARES act we’re going to focus on today is the removal of the 10% penalty for early withdrawal from your retirement accounts as long as your withdrawal is under 100,000 dollars.
If you have an IRA, 401k, or other retirement account, you normally get penalized for taking a withdrawal from those accounts before you turn 59 and a half. Usually that fee is 10 to 25 percent of the amount you withdraw early depending on what kind of account you have. Normally, early withdrawals aren’t penalized if you have a hardship like avoiding foreclosure, fixing your home after a disaster, or medical expenses. But, the IRS has specified some additional conditions where the early withdrawal fee is waived in 2020 for those affected by COVID-19.
Those conditions are:
-You, your spouse, or dependent test positive for COVID-19
-Your start date for a job was delayed
-Your job offer was rescinded
-You were laid off or furloughed
-You had to quarantine
-Your pay or work hours were reduced, including self-employment income
-You had a reduction in business or had to close entirely
-You couldn’t work because you didn’t have access to childcare anymore
-If your spouse or member of your household met any of those conditions, then that also qualifies you to be exempt from early withdrawal fees.
Do any of those conditions apply to you? Then you’re allowed to take an early withdrawal without penalty. You’re also not limited to only withdrawing the exact amount of financial hardship you incurred. If you (somehow) calculated that you incurred a 17,213 dollar and 53 cent hardship due to this Coronavirus, then you aren’t limited to withdrawing only that amount. You can still withdraw up to 100,000 if you like.
However, if you’ve seen articles online or news blurbs saying that you can withdraw up to 100,000 from your retirement penalty-free, then don’t be misled. You still have to pay income tax on your withdrawal amount at your regular marginal tax rate! So, that money is not free. Uncle Sam still gets his due-and-proper. There is good news, though. The IRS will allow you to spread the taxable portion of that income over the next three years if you wish. You can also payback some or all of your withdrawal before your taxes are due that year and not have to pay income taxes on your withdrawal. If you elect to spread that tax hit over the next three years, then you can also re-contribute to those same funds over three years to avoid being taxed. Also, we should be clear that if you have multiple retirement accounts you can’t withdraw up to 100k from each of them. The 100k is a total amount you can withdraw from whatever retirement plans you have.
Also, if you’d rather take a loan from your 401(k) then the limit is 100,000 versus the regular 50,000. If you’re over 70 and a half, then the Required Minimum Distribution, or RMD, is waived for 2020. This is good news if your portfolio has taken a big hit this year and you don’t want to be forced to liquidate some of it to meet your RMD.
When I was researching this topic, my big question was this. How do you prove you were impacted, and who do you declare it to? If you’re taking a distribution from your employer’s sponsored plan, then the administrator of that plan may need a letter from you stating that you’re qualified to take the distribution without penalty. If that’s the case, head to our website for a letter you can download and present to your plan administrator. We plucked it off the IRS circular about this subject so you could say it’s IRS approved. Go to highyieldre.com/podcast/COVID to download the document. We’ll also provide a link to the IRS circular if you want to read the specifics on this subject yourself, or get to sleep on a sleepless night. At this point, there is no specific proof requested beyond completing this document, so check by the end of 2020 whether the IRS has further guidance on proving your financial hardship (either with them, or with us). If you rollover or transfer your IRA or 401k into your own brokerage, then this type of withdrawal is just a few mouse clicks away and no letter submission may be needed.
So why are we telling you all this if we’re a real estate investing podcast? For one, you can use retirement funds to invest in real estate. But what if you’re like me and want to reach financial independence well before 59 and a half, so all that money stuck in retirement accounts is slowing you down? Right now is a unique opportunity to save 10% on taxes if I qualify and decide to withdraw those funds early to reach my goal faster. Let’s suppose I withdrew 100,000 and this income lands me in the 32% tax bracket. Well, that’s 32,000 dollars in income tax owed and an additional 10,000 dollar penalty fee for early withdrawal. That’s 42,000 of that 100,000 that I’ll pay in tax. Well, now if I withdraw in 2020 it’s only 32,000 that uncle Sam gets his hands on.
We aren’t financial advisors or planners so we aren’t going to tell you what you should do with your money. Conventional wisdom says you shouldn’t withdraw from retirement accounts unnecessarily, and that you shouldn’t make a withdrawal unless you really need it even if you do qualify. Consult your accountant about your specific tax situation. But if you are considering taking advantage of an early withdrawal without penalty, the last day to do so will be December 31, 2020.
Thanks for listening! If you’d like to learn more, visit our website highyieldre.com. There you’ll find a complete list of previous episodes with transcripts and a free property analyzer you can download. Remember to subscribe for updates on new episodes being released. You can also find us through your favorite podcast service or Youtube. You can contact us through our website or by emailing info at highyieldre.com