With little more than a week left to take tax-friendly withdrawals from individual retirement accounts and 401(k)s under the Cares Act, people stung financially or physically by Covid-19 are making last-minute decisions while wading through a thicket of rules that could have an impact on future taxes. To help readers navigate the rules, Barron’s Retirement has been looking for answers and expert guidance.
I’d like to take $90,000 out of my IRA before the Cares Act runs out this year. If I do that, will I have any control over when I pay the taxes or will I owe taxes on $30,000 every year for three years? I’m not eager to pay taxes this year because my taxes will be a lot lower during the next two years.
Barron’s Retirement: You have some control, but not as much as you’d probably like.
The Cares Act lets people of any age take up to $100,000 from their IRA or 401(k) by Dec. 30 without a penalty. But those who take a withdrawal do have to pay income taxes on it unless they return the sum to their IRA or 401(k) within three years.
People can choose one of two ways to pay taxes: Either the person pays taxes on the full distribution by the time they do their 2020 tax return, or the person can spread tax payments over three years ending with the 2022 tax return in 2023.
Those who had low income during the pandemic might welcome the 2020 tax return option. Getting the tax out of the way during a low-tax year could be bearable and leave no taxes leftover when incomes improve.
But someone like you, who expects lower income and taxes over the next two years, might prefer the three-year repayment option.
It would work like this: You would take $90,000 out of your IRA before the Cares Act provision expires Dec. 30. Then you would declare that withdrawal as income in three equal amounts during each of the three years. So for your 2020 tax return, you’d declare $30,000 in income and owe taxes on it. For your 2021 and 2022 tax returns, you’d do the same.
The one way to offset the income and reduce or eliminate the tax would be to pay back into your IRA some, or all, of what you removed.
In your case, if you take $90,000 out of your IRA on Dec. 30 this year, you could eventually get all the taxes you paid, plus interest, returned to you if you put the full $90,000 back into your IRA by Dec. 31, 2023, said IRA expert Ed Slott.
You would have to file an amended tax return for 2020, 2021, and 2022 to get refunds.
That said, if you don’t want to pay back the full $90,000 within the three years, there is another option. You could pay back a portion of the money, and time repayments to relieve a high tax year. For example, you could return $30,000 to your IRA by the time you submit your 2020 tax return and avoid adding income to this year’s tax bill. Alternatively, if you expect high income in either 2021 or 2022, you could pick one of those years to replenish $30,000 in your IRA, said Slott.
Keep in mind, if you are younger than 59½, the Cares Act is a one-time opportunity for those who suffered from Covid-19 to tap retirement funds without a penalty.
If you are over 59½, you can remove retirement savings at any time and pay taxes on any distribution in the year you do it. Julie Welch, an accountant and financial planner in Leawood, Kan., said that if this is a high tax year, skipping the Cares Act and instead taking a regular distribution from your IRA next year may be more effective from a tax standpoint.
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