Here is a guide on how to manage taxes on Covid-related withdrawals from retirement accounts
MoMo Productions | DigitalVision | Getty Images
That early withdrawal from your retirement account last year could have been a lifesaver. Now it’s time to pay the tax officer.
Most retirement savers haven’t made a legal distribution that allowed penalty-free early withdrawals amid the pandemic.
For those who have, however, the majority (69%) say they either have no plans to replace the money they withdrew or, according to recent research by the Principal Financial Group, they cannot. Another 18% intend to repay part of their payout and 13% say they will replace the full amount.
Note that you need to include at least a portion of the taxes owed on your 2020 tax return – which is due May 17th. Depending on the tax form you received, additional steps may be required to ensure you don’t pay a fine.
“Probably the hardest thing will be how the distribution was reported and whether you will receive the benefit and not be penalized,” said April Walker, senior manager of tax practices and ethics at the American Institute of CPAs.
The CARES bill, signed by then-President Donald Trump last March, allowed individuals to withdraw up to $ 100,000 from their retirement accounts without paying the usual 10% tax penalty if they were under 59½ years old – as long as this was the reason for the distribution, Covid was related.
These reasons could include you or your spouse being diagnosed with Covid, being laid off from your job, or working fewer hours.
First, it’s important to remember that with traditional 401 (k) plans and individual retirement accounts (Roth versions have different rules), you generally don’t pay tax on your contributions.
However, when you withdraw, you must report the income and pay tax on it. This is the case even though the CARES Act eliminates the 10% early withdrawal penalty.
While the temporary rules allow you to spread the distribution out over three years, you must factor in at least a third of the tax due on that amount when you return it in 2020, Walker said.
More from Personal Finance:
This is what travel could look like after a pandemic
How much do you have to earn to be able to afford a house?
Tax refund fraud is aimed at students and employees
If you were to repay the amount paid out within the three-year period permitted by CARES, you would have to file amended tax returns to get back what you paid Uncle Sam.
You should receive a Form 1099-R showing the amount that you have withdrawn from your eligible retirement account. Remember, the IRS will also get a copy.
There should be a distribution code in field 7 of the form. If the code listed is “2”, it means the amount you received from your plan in 2020 was for a qualified reason under the Cares Act, Walker said.
However, if the code field contains a “1”, you will need to fill out a Form 8915-E to certify that your distribution should qualify under CARES, she said.
“The form itself asks what the distribution is for,” she said.
Form 8915-E is typically intended for disaster distributions and allows you to report early withdrawal over three years.
It’s also worth noting that there is a chance that using this form could pique the interest of the IRS, Walker said.
“There is a chance that correspondence will be generated saying that you are telling us more about why you are encountering an exception,” Walker said.
This would generally require proof from the IRS that the distribution is qualified.
2020 RMDs can qualify
The CARES Act also removed the required minimum payouts for 2020, allowing anyone who wanted to reverse an already withdrawn RMD last year to do so. These RMDs, which are annual amounts that must be withdrawn from your retirement account from the age of 72, are back in effect for 2021.
If you happened to take an RMD in 2020 and haven’t put the money back, it’s worth seeing if the payout qualifies as a Covid-related distribution under CARES, Walker said.
“It could be that you received the RMD and later find out that you qualify,” she said.
The benefit would be the ability to spread this income over three years (and the taxes due).