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CARES Act Early IRA Distribution Could Be Bad Choice

Posted on May 22, 2020

A provision in the coronavirus relief bill allows individuals to take penalty-free early distributions from their retirement accounts, but doing so could expose once-protected assets to creditors.

The provision of the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136) allows qualified individuals below retirement age to take a coronavirus-related distribution (CRD) of up to $100,000 from their retirement accounts without paying the 10 percent early distribution penalty and is intended to give taxpayers in need of cash the ability to tap into their retirement funds.

Many states offer unlimited creditor protection for IRA and retirement plan assets, and taking an early distribution, especially during a time of economic turmoil, could turn out badly for some taxpayers, Alan S. Gassman of of Gassman, Crotty & Denicolo PA said on a May 21 webinar sponsored by Leimberg Information Services Inc.

For example, once the COVID-19 crisis starts to settle down, an individual who opted to take a CRD from their retirement plan could find that their business can no longer support them the way it used to and goes bankrupt, and they won’t be able to put those funds back into the IRA because it will be treated as a transfer to avoid creditors, Gassman said.

That’s if the taxpayer still has the funds to restore. “Thousands of Americans will withdraw $100,000 or whatever they have in their retirement plans and then promptly spend it or lose it,” Gassman predicted.

Rather than take a CRD, most taxpayers would be safer liquidating or borrowing against their other assets like vacation homes or boats, even if it’s at a high interest rate, Gassman said.

Pays to Be Rich

For affluent taxpayers, however, taking a CRD might be a savvy move, Gassman said.

If a wealthy individual has a retirement plan worth $100,000 now but expects it to be worth twice that in the next three years, then they could be better off taking the CRD now, because asset values may be low, the individual might be in a lower-than-normal tax bracket this year, and they might have losses that could offset the ordinary income tax on the distribution.

Then the wealthy individual would be left paying just capital gains taxes on the portfolio if they sell appreciated assets, or they could avoid capital gains altogether if they hold on to the assets until they die, Gassman explained.

“So while Joe Sixpack is probably going to make a mistake and this provision will cause more harm than good, the people he works for may want to take the [$100,000] out,” Gassman said.

Follow Jonathan Curry (@jtcurry005) on Twitter for real-time updates.

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