Having a 401(k) with your current employer is a good thing. A 401(k) or similar employer sponsored retirement plan is a great vehicle for accumulating tax-sheltered retirement savings. If your employer offers a match or profit-sharing component, that is essentially free money or a 100% return on investment, depending on how you look at it.
But about the investment choices…
Most 401(k) plans have limited offerings of a handful of mutual funds. That is not diversification, and that is not a means to take full advantage of the wealth building potential of a tax-sheltered retirement plan.
We hear from investors all the time who want to be fully diversified and invest in real estate, notes, private equity, or other alternative assets with a self-directed IRA, but their funds are locked up in their current employer plan.
Another problem with most 401(k) plans is that you cannot take money out to rollover to another plan while you are still working with the company unless you happen to be over age 59 ½. There are some exceptions with plans designed to offer “in-service distributions” on a more liberal basis, such as a lower age threshold, certain number of years of service, etc., but that is rare.
Well, here is some good news. Between now and the end of 2020, you may have the option to unlock that current 401(k) plan and move some capital to a self-directed IRA or Solo 401(k) plan.
The CARES Act
In response to the Coronavirus pandemic, Congress in March passed the Coronavirus Aid, Relief, and Economic Security Act – the CARES Act. The act implements several changes with respect to retirement savings aimed at allowing citizens to access 401(k) savings as a means to keep afloat in the economic chaos created by COVID-19 and attendant business shutdowns.
While not exactly the intent of the law, some investors may be able to utilize one of these provisions to move funds out of a current employer plan.
Coronavirus Related Distributions
One feature of the CARES Act is what is referred to as Coronavirus Related Distributions or CRD. This section of the act allows for a distribution of up to $100,000 from a current 401(k) or IRA and eliminates the 10% penalty for early distribution prior to age 59 ½ that normally applies. With a CRD taken between the passage of the act in March and December 31st, 2020, you also have the ability to return that money into a retirement plan within the next 3 tax years and eliminate any tax burden. In effect, this is allowing for a 3-year rollover period. This last bit is the trick.
Via the CARES Act, qualifying individuals can take a taxable distribution of up to $100K from their current employer plan. If they then put that money into the same or a different retirement plan before December 31st of this year, it is effectively treated as a rollover and becomes non-taxable.
In order to be classified as a Coronavirus Related Distribution an individual must be impacted by COVID-19 in one or more of the following ways:
- They have been diagnosed with COVID-19
- A spouse or dependent has been diagnosed with COVID-19
- They are experiencing financial difficulty as a result of being laid off, furloughed, having work hours reduced, or by being quarantined
- Are unable to work because of a loss of childcare as a result of COVID-19
- Own a business that has closed or is operating under reduced hours
- Meet other criteria as determined by the IRS
In additional to qualifying for a CRD, your employer must elect to support the provisions of the CARES Act. It is believed most employers will, but you will need to check with your plan administrator to be sure.
The CRD provisions also eliminate the need for normally mandatory 20% withholdings by the plan administrator. This means the full amount distributed is directly available to you.
If you wish to use the CRD provision of the CARES Act to facilitate a rollover to a new or existing self-directed IRA, use the following steps:
- Ensure you qualify for a CRD based on impact from COVID-19. A discussion with your licensed tax advisor may be appropriate.
- Ensure your plan administrator has elected to implement the CARES act provisions.
- Verify the amount you are eligible to distribute from your plan, up to $100K. Certain contributions by your employer may not be vested and therefore may not be able to be rolled over.
- Confirm that taking a distribution does not impact your ability to continue to make new contributions to the plan going forward. It should not, but it is wise to check.
- Setup a new Self-Directed IRA if you do not already have one in place.
- Issue the request for a CRD. Funds will be issued to you, not directly rolled over to the new IRA.
- Deposit the CRD to your personal account.
- Send the desired amount from your personal account to the Self-Directed IRA custodian. Report this as an indirect rollover.
Your current plan administrator will issue form 1099-R indicating the distribution as taxable to you.
The receiving self-directed custodian will report to the IRS on form 5498 and will indicate the receipt of a rollover deposit. This will cancel out the taxable event of the initial distribution.
You will also indicate that the rollover took place in line 4 of your 1040 and illustrate a taxable amount of $0.00.
What if You Actually Need Some Money from your 401(k)?
If the qualifying impact of Coronavirus has actually put you in a financial bind, you can use the Coronavirus Related Distribution for personal purposes instead of immediately rolling it over to a self-directed IRA.
In this scenario, you still have two options to consider with respect to using the CRD funds for a rollover to a self-directed IRA.
You can distribute the full amount available up to $100K from your existing 401(k), take some to live on, and rollover some to a self-directed IRA. You will then pay taxes on the portion you keep personally.
Within a 3-year period through December 31st, 2024, you still have the option to replace funds taken from a retirement plan via a CRD. Once you get past December 31st, 2020, you will have to pay taxes on the distributed amount. You can do so in full or split that tax amount over the 3-year window. If you then return funds to a retirement plan before the end of the 3-year period, you can file an amended return for any applicable tax year to claim a refund of the taxes paid. Under this framework, you might take a distribution to solve a current financial pinch, later get back on your feet, and then put money into a self-directed IRA instead of back into the original 401(k).
Proceed with Caution
Taking a large distribution from a retirement plan is a big financial decision with considerable potential impact. It may be very possible to seamlessly move funds from a retirement plan with limited options to a self-directed plan that can invest in anything the IRS rules allow for. Doing so requires a few steps in the proper order and correct reporting, however, so be sure to do your homework and work with professionals as you embark upon the task if you choose to do so.