When you look at the CARES Act, there are two main areas for individuals to focus on: economic impact payments and retirement accounts.
The economic impact payments are the checks that everybody is talking about. The check is really a prepayment of a 2020 tax credit. With these credits, every adult is starting out with $1200. I get $1200 and my wife gets $1200. If you are looking at an individual, you get the $1,200 if your income is below $75,000. Once you go above $75,000, you start getting phased out of this benefit. If you have a qualifying child below the age of 17 by the end of 2020 you get an additional $500. My wife and I have four kids. We would get $500 for each kid, an additional $2000. Once they establish the base amount you are eligible for, they look back at either your 2018 return or your 2019 return if you have already filed for 2019.
Imagine a couple who was married in 2018 but got divorced in 2019. The husband was a high earner, the wife stayed at home. The wife may have started working, but not at a high-income level. If the IRS uses that 2018 return where the husband had a high enough income, it is possible that they both will be phased out completely. There may be some single parents who are not getting any immediate help. There are two important things to remember. If you currently are qualified to receive a payment, you will receive the payment when you file your 2020 tax return. And if you have already received a payment but won’t qualify on your 2020 return, you will not be required to pay back the payment. There will be some reconsideration about how the payments are handled, especially with a recently divorced couple.
The other aspect are retirement accounts, such as IRAs and 401(k)s. After a hurricane, flood, or tornado, the government will set up federal disaster area. If you are inside of that area, they allow you to take distributions from a retirement account without penalty. The government has done something similar with Coronavirus.
If you have been diagnosed or directly impacted by the Coronavirus, you may have the option to take a distribution from your IRA. This exception may allow you pull up to a $100,000 from an IRA and avoid the 10% penalty. You then have three years to pay this money back. If you do not pay it back, it turns into ordinary income. If you’re in the middle of a divorce and facing financial hardships, it becomes another way to generate some liquidity.
In some situations, a coronavirus IRA distribution may be more attractive than a QDRO from a 401(k). When taking a QDRO distribution from a 401(k), federal law requires that you withhold a minimum 20% for taxes. When taking $100,000 from a 401(k), you are getting $80,000, and $20,000 goes directly to the IRS. Coronavirus distribution have no automatic withholding for federal income tax. In addition, with a coronavirus distribution, you have the option to spread the income equally over the next three years.
For a 401(k), if you are still working, there may be another tool that you have for divorce planning and trying to access additional liquidity. The loan limit for a 401(k) has been increased from $50,000 all the way up to $100,000. If you have a $48,000 account, you can take a $48,000 loan. If you have a $75,000 account, you can take a $75,000 loan. There’s no longer that lower percentage threshold. The max you can take out is $100,000 or 100% of the account, whichever is lower.
There are a couple of things to be aware of. Although the CARES Act allows for the increased loan amount, plan administrators are not required to allow participants this option. Also, if you leave your job while you have an outstanding loan, you will be required to pay back the balance. If you don’t pay it back, the amount will be treated as ordinary income and subject to a 10% penalty.
With the 401(k)s, you have until September 22nd of this year to take that $100,000 loan. On the IRAs, you need to make sure it is done in 2020.
When in the process of divorce, liquidity of assets needs to be considered during discussions of who gets what. Especially if you are currently unemployed and we have no clarity when the effects from the Coronavirus will end. Cash is king right now.
Hedgefield Wealth Management is a registered investment adviser. Hedgefield Wealth Management does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
