Q. I withdrew $30,000 from a qualified IRA as an early withdrawal in January of 2020. Twenty percent was withheld for taxes as was the 10% penalty. What should I do to get the penalty monies returned?
— Confused
A. The coronavirus pandemic has forced many Americans to exhaust their savings and emergency funds after job losses.
Congress recognized that for many, the ability to access retirement savings is a necessary lifeline to financially weather the pandemic.
Under the CARES Act, retirement distributions taken prior to age 59 ½ in 2020 because of coronavirus-related hardships will not be subject to the 10% early withdrawal penalty, said Matthew Defelice, a certified financial planner with U.S. Financial Services in Fairfield.
“The CARES Act provisions apply to any distributions made in calendar year 2020 up to $100,000,” DeFelice said. “However, in order for your withdrawal to avoid being subject to the 10% penalty you must be considered a `qualified individual.’”
The requirements are fairly liberal, DeFelice said.
A qualified individual is anyone who has been diagnosed with COVID-19 by a test approved by the CDC or has experienced adverse financial consequences due to being quarantined, furloughed, or laid off; having work hours or pay reduced; having been unable to work due to a lack of child care; having owned or operated a business that has been closed; having a reduction in self-employment income; or having a job offer rescinded or a start date delayed.
An individual also qualifies if his or her spouse or a member of his or her direct household has experienced any of the above.
DeFelice said a qualified individual is not required to demonstrate a true need for the funds in order to take advantage of this provision.
“As long as an individual has experienced adverse financial consequences for any of the reasons listed, an early distribution is allowed,” he said. “Additionally, the amount of the distribution is not limited to the extent of adverse financial consequences experienced.”
Provided any of these conditions are met, the eligible distributions must be reported as 2020 income, but without the additional 10% penalty for early distribution, he said.
Income tax will still be due, but qualified individuals will be allowed to spread the tax liability over the next three years if they choose, DeFelice said.
So if you withdrew $30,000 in 2020 you may report $10,000 of income in 2020, 2021, and 2022.
“This election must be made when you file your 2020 taxes, so if you take advantage of the three-year rule you will only be responsible for income tax on $10,000 this year,” he said. “In that case you should receive a refund back for the 10% penalty and whatever portion of the 20% withholding above what you’ll owe on a $10,000 distribution.”
You may opt out of the three-year provision and pay the income tax due on the full $30,000 distribution with your 2020 taxes, he said.
“If you opt out, this election must be made by the date the tax return is filed and may not be changed afterward,” he said. “What you do will depend on your personal situation, and you should consult with your CPA to determine the most tax-efficient strategy for you to declare this income.”
Email your questions to Ask@NJMoneyHelp.com.
Karin Price Mueller writes the Bamboozled column for NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. Sign up for NJMoneyHelp.com’s weekly e-newsletter.