Penalty Free IRA Withdrawals in 2020 – 3 CARES Act Rules


During normal times, taking an early withdrawal from your IRA is generally a bad idea. Not only will you owe taxes, but you’re also subject to the 10% penalty for withdrawals before age 59-1/2. However, for those impacted by COVID-19, the CARES Act allows for a penalty free IRA withdrawals in 2020, subject to a few rules.

Who Is Eligible?

Anyone who has been impacted by the COVID-19 pandemic is eligible to make a penalty free IRA withdrawal in 2020. This includes:

  • Anyone who has tested positive for COVID-19,
  • Anyone whose spouse or dependent has been diagnosed with COVID-19,
  • Anyone who has been financially impacted by a pandemic-related job loss, furlough, reduction in hours, quarantine or loss of childcare.

Of course, for anyone over age 59-1/2, penalties wouldn’t have been an issue for you in the first place.

Rule 1. Maximum Penalty Free IRA Withdrawals in 2020

In order for an IRA withdrawal to be penalty-free this year, the CARES Act limits the maximum withdrawal amount to $100,000. Any amount that you withdraw over $100,000 will be subject to the 10% early withdrawal penalty, so keep that in mind if you think you may need more.

Obviously, Uncle Sam doesn’t want you to take too much out of your IRA this year.

Rule 2. You Can Pay The Taxes Over Three Years

While the penalty may not apply to an early withdrawal this year, you will still have to pay taxes on the withdrawal amount. Fortunately, the CARES Act allows you to pay the taxes associated with these penalty free distributions over three years.

That means that you will not be required to make a big tax payment in April of 2021. Instead, you can stretch the associated taxes over 2021, 2022 and 2023, easing the cash flow impact of your tax bill. You could even wait until 2023 to pay the entire tax bill at once, if that works better for you.

Rule 3. You Can Replace The Funds And Owe No Taxes

One really useful rule created by the CARES Act is that, if you redeposit the amount that you withdrew within three years, you will owe no taxes or penalties.

This essentially turns your early IRA withdrawal into a tax-free, penalty-free, no interest loan for three years. In three years if you find yourself in a position where you can replace the funds, this may be a great option.

Your 401(k) May Be Eligible

It’s important to note that some 401(k) plans may differ slightly from others, depending on the company and plan administrator. One of the places where 401(k) plans can differ are their hardship withdrawal rules.

If you think that you may want or need a penalty free 401(k) withdrawal this year, you’ll need to talk to your plan administrator. This option may be available for you. However, you may be required to supply proof that you have indeed been affected by the pandemic.

Is This A Good Move?

Under normal times, early retirement plan withdrawals should be avoided in most cases. However, since the CARES Act has done away with the 10% early withdrawal penalty this year, there are some strategic opportunities that exist for people in the right circumstances.

If your income is significantly down this year, then taking a penalty free IRA withdrawal could be a smart move. If you’ve been furloughed, had your salary reduced or seen your incentive or bonus compensation drop significantly, then you may want to investigate further.

Business owners and commission-based sales professionals, in particular, could benefit from this strategy if their 2020 income is significantly lower than expected. Even if you don’t need to use the entire withdrawal for living expenses or coronavirus related issues, 2020 represents a unique opportunity to get assets out of your IRA without suffering penalties.

Given that (at the time of this writing), markets have recovered for the most part. So, liquidating assets at a steep discount isn’t the concern it would have been in March.

We’re Here If You Need Us

If you need help deciding if penalty free IRA withdrawals in 2020 are right for you, then click here to set up a quick, complementary introduction call to see if Prana Wealth is a good fit. We do still have capacity to take on new clients this year.

As a fee-only financial advisor in Atlanta, we can (and do) work virtually with clients all across the U.S. In the past, we’ve helped plenty of clients think through these types of one-off strategic opportunities. We’re here to help you when you’re ready.

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