Episode 15: Issues with the CARES Act

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Welcome to Revamping Retirement, a podcast brought to you by Comac Retirement Group, where we tackle the retirement plan related issues plaguing fiduciaries and plan sponsors. Our host, Mike Webb, has more than 25 years of experience in the retirement plan industry and is a nationally recognized subject matter expert. We hope you enjoy Revamping Retirement.  Thanks, Karen. Karen McCauley, our wonderful producer, as always.

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My name is Mike Webb and you’re here for hopefully another informative and entertaining dare I say, entertaining episode of Revamping Retirement. Hope everyone’s staying safe out there during this terrible COVID-19 pandemic. We’re gonna talk a little bit about some COVID-19 relay issues again this month on revamping retirement and we’re gonna address some of the CARES Act provisions that were.

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enacted in response to COVID-19. And we’re going to talk a little bit about this time about how Congress could have done better with the CARES Act. There’s some decent provisions in there, but there’s definitely some things that could have been improved upon. Hopefully they’ll address some of these issues in future legislation. But before we get started, of course, we have our trivia question. And trivia question is actually about the CARES Act. And it goes as follows.

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The CARES Act, as you know, amended distribution and loan provisions allows you to borrow a lot more for COVID-19 related reasons and receive distribution specifically for COVID-19 related reasons. Which of these two provisions or both are effective for the remainder of 2020? In other words, they’re effective through the end of this year. Is it just the loan provisions effective for borrowing new loans for the new COVID amounts?

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Is it the distribution provisions, being able to take a withdrawal for COVID-19 related reasons? Is it both or is it neither? And we’ll have that answer for you at the end of our podcast as always, but if you can ponder that while I dive right in, that’d be great. And we’ll go right into the CARES Act issues, which are related to, again, what Congress could have done better. Well, the first thing they could have done better, and this was kind of a no brainer, and I was very

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disappointed that it actually didn’t happen is a lot of the industry lobbying groups had actually lobbied for this more than once, but it just didn’t happen and that is in relation to the 10 % premature distribution penalty. We try to do complicated phrases to describe really, really simple things in retirees, but it’s gotten the name of 10 % premature distribution penalty over the years. And what it really means is taking distributions under age 59 and half. Now there are some exceptions or if you separate in the year you turn 55 or later, you’re exempt from that.

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But in general, you take distributions under 59.5, not only are responsible for ordinary income taxes, but a 10 % penalty. And it’s always been a very draconian penalty, and I’ll explain to you why. It makes people all the IRS who could least afford it, basically. And who is that? Well, people under 59.5 who’ve lost their job because they’re taking the money, and people under 59.5 who have a hardship, because that’s the only way you can take money out of retirement plans. You know, they’re not like ATMs, you can’t…

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freely or willy-nilly take money out of retirement plan accounts, and even with COVID-19 you can’t take money freely, you to have a COVID-19 reason. So we’ve basically limited these distributions to the people who need them the most. People who get terminated and maybe don’t have another job, so they have to take their money, and people who proven a hardship, with the exception of buying a house, I know that’s not a hardship, but most of them are people behind their rent, behind their mortgage, and the problem there is that we’ve punished those people over the years.

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We’ve said, okay, we’re going to target those people specifically. Not the people who don’t need the money or take the money, but the people who really need the money and need the money. We’re not only going to make them pay taxes plus 10 % penalty. And of course, they’re in such desperate states, they’re taking the money anyway, they have no idea that when they go to pay the tax man, that it’s a tremendous tax burden a lot of times. They basically end up owing the IRS instead of owing their creditors, which is even worse. So we were hoping that the CARES Act would get rid of that draconian penalty, at least temporarily, perhaps permanently, because it’s just a silly penalty. Anyway.

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But unfortunately, what they did was they only got rid of it for COVID-19 distributions. And, you know, that’s great. It’s wonderful they got rid of it for COVID-19 related distributions, but COVID-19-related distributions are not need-based. So I could be laid off, go right back to work for somebody else. And I don’t have to prove a need so I could take my money out of my old plan. And that’s a COVID-19 reason. You know, it’s great that it’s off of COVID-19, but again, now people with real hardships.

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hope to happen to fall into one of the categories of COVID-19 reasons and as it stands now if you’re if you get laid off you can take a COVID-19 distribution but if your spouse gets laid off you can’t. Your spouse has to actually be sick from COVID-19 for you to take a distribution for a spouse event. So you might not fall into that category and then now let’s just say your spouse lost their job and you have to take a COVID-19 related distribution but it really doesn’t qualify for COVID-19 you’re not gonna have to prove hardship and you’re still gonna have to pay the 10 % penalty. See the people

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who have non-COVID-19 hardships are being punished. Absolutely punished by Congress, by the CARES Act. And it makes absolutely no sense to me. They sure it has gotten rid of it for everyone, but end rant on there. We’ll go to the next two, my top three. Hopefully they’ll address it. your guidance. Second biggest one is they now allow you to borrow for a COVID-19 reason up to your entire camp balance or a hundred thousand, whichever is less, but they didn’t extend the repayment term. That’s like the no brainer would have been, Hey, you know,

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For home loans, we’ve already extended the repayment term longer than five years because we know when people are buying a house, they tend to borrow more money. Well, guess what? If we’re allowing them to borrow more money up to $100,000, it’s an absolute no-brainer that they extend that loan repayment term past five years. And they didn’t do it. So here’s what’s going to happen. I can boldly predict this. Unless regulatory guidance or another COVID-19 related relief bill comes along and corrects this, you’re to have people borrowing $100,000 this year.

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being unable to pay it back because not only is it $100,000, they get a payment holiday—that’s another CARES Act provision, for the rest of this calendar year. So they have $100,000 plus the accrued interest that they’re not going to have to pay off starting in 2021 over only a five-year period. So that’s not very long. Those payments are going to be huge. And most people, they need the money in the first place. So how are they going to pay this off? So they’ll go into default. And if you went into default this year, you actually had some relief. You could take your default

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and reclassify it as a COVID-19 distribution and actually be able to spread the tax burden out over three years or even pay some of it back. You kind of get a holiday on the default almost, if you will. But that relief does not apply in 2021 or beyond. So people are going to default on these loans next year. They’re going to be subject to ordinary income taxes, a 10 % penalty with our under 59.5. And guess what? They’re going to owe a massive amount of money to the IRS because the tax bill is going to come and they’ll have no way of paying it.

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So that’s pretty horrendous. So another no brainer hopefully for Congress is, stand alone repayment terms for COVID loans to 15 years at least, so that people have a decent shot of not defaulting on it. That would be nice. And the last thing I have that’s an issue with the CARES Act is, we actually punished people under the RMD rules for taking their 2019 RMDs on time, required minimum distributions for those of you not familiar with the term RMD.

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It’s the thing they have to take every year after they turn 72 now. It used to be 70 and a half. Well, the people, enough, who were already behind the 8-ball, who turned 70 and a half before 1-1-2, 2-1-2, 20, 12-3-1-19, or before, who had to take a distribution under the old rules, under the new rules, you don’t have to wait until 72, if they timely took their distribution, in other words, they were really good, they took it by the end of 2019, instead of waiting April 1st, when they ostensibly would have had to take two distributions in 2020, if they were on time,

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The IRS just beat them over the head. They’re like, congratulations. You took your required minimum distribution on time, know, on an inflated account balance, by the way, because the account balance was much higher last year. I took, you took it on time and your reward is, is that you’re, you’re not going to be able to waive your minimum required distribution. If you waived it, you waived it for your 2019 distribution until April 1st, and you didn’t take it as yet, or even if you did take it, there’s some relief available, but only in 2020.

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So if you wait until April 1st or April 30th, guess what? You don’t have to take it now, it’s waived. Even if you take it before April 1st or April 30th, if you took it from February 1st to April 1st, you can repay it back to your plan if your plan allows it, or any other plan or IRA that you have that accepts rollers. Right now it’s unclear what happens in January 2020 minimum required distributions, but it’s probably going to be the same thing. They’re going to be able to roll it over. And if they have an issue in 2020, it’s going to be easily addressed. In 2019,

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They were rewarded for their timeliness. The IRS saying, eh, I’m sorry. You can’t repay the distribution. You’re going to be taxed on it. And it’s going to be a higher account balance anyway. That was just terrible, in my opinion. So hopefully they’ll come up with some guidance there that maybe the 2019 people won’t be punished for having been timely on their 2019 distributions. Anyway, those are the three things. Otherwise, know, Congress did a pretty good job. Nice relief for people. Definitely those three things I think they need to give some thought to in future legislation or IRS needs a

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talk about in regulatory guidance. I want to get to the trivia question. Loans and distributions—you know, a lot of these new COVID loans, a lot of these new COVID distributions. Can you do it between now and the rest of the year for loans, for distributions, for both or neither? The answer to kind of a trick question, it is neither. You can take the new COVID-19 distributions, but only through December 30th, due to a quirk in the CARES Act. You can’t take them on December 31st, so technically you can’t take them for the entire rest of the year.

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Hopefully again, future legislation will address that, corrections bill hopefully. And then for loans, you can only take the new COVID 100K loans up to your entire account balance until September 22nd. So there’s very narrow deadline on that, unless extended, and it could be extended, obviously, obviously if the pandemic goes on. So hope you enjoyed playing our favorite question. Again, the answer was neither of those things are allowed for the entire remainder of 2020. A little bit of a trick question. For Karen McCauley and our entire production team.

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I’m Mike Webb and this has been Revamping Retirement.

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The content in this podcast is for institutional investors and plan sponsors. The information is intended to be educational and is not tailored to the investment needs of any specific investor. All examples of investor gains and losses are hypothetical and intended to illustrate the importance of early saving and consistent retirement contributions over time. Investment decisions should be based on an individual’s own goals, time horizon, and risk tolerance. Nothing in this content should be considered as legal or tax advice and listeners are encouraged to consult their own lawyer.

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accountant or other advisor before making any financial decision. Thank you for listening to Revamping Retirement.