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The Stimulus Plan and Its Effect on Retirees

Tax and retirement planning expert Ed Slott says investors should tread carefully among the potential provisions, from RMDs to hardship withdrawals and loans.

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Christine Benz: Hi, I'm Christine Benz from Morningstar.com. Congress is on the verge of passing a stimulus plan that would allow retirees to skip required minimum distributions for 2020, among other relief measures. Joining me to discuss some of the measures we expect to see included in the final law is Ed Slott. He's a tax and retirement planning expert.

Ed, thank you so much for being here.

Ed Slott: Hi Christine. Great to be here. Thanks.

Benz: Ed, this is not yet final, but one thing that you believe will be in the final package is a provision that would allow retirees who would otherwise be subject to required minimum distributions to not have to take them for 2020. So the virtue of letting them do that is that they can allow their balances to repair and regrow.

Slott: Right, yeah. This is going to help a lot of people. Not as many as you think, but the big thing here, remember your 2020 RMD is based on the balance as of 12/31/19 when the Dow was around 28,000. You're going to be taking, if not for this relief, probably a lot more money would have to come out. The calculation would be the same. The percentage would be a lot more, resulting in a larger tax bill on value that's no longer there.

Benz: So the question is, Does it generally make sense for retirees to delay if they have this option?

Slott: Oh yeah, but obviously if you can cut your tax bill ... well, you know what? I shouldn't say, "Oh yeah," across the board, because there may be people that say, "You know, I'm in a low bracket. Even if there's no RMD, I might want to take something out. Maybe not the required amount, some other amount to keep me in a low bracket and use up the rest of that maybe 10, 12, 22% bracket." So, if for tax-planning purposes, just as a regular planning item where you might be taking a little down each year to bring that balance down at low rates, you could do that. 

But one thing you could do now that you couldn't do before are RMDs were never allowed to be converted to a Roth IRA. Now that that's not a requirement, there's no RMD. So maybe that's a scenario, a planning idea, where you can take whatever you want and stay in a low bracket, but as long as you're going to take it out, you may as well convert it to a Roth IRA and have it grow tax-free, and there's no RMDs for lifetime in the Roth.

Benz: You noted that there's some urgency around this measure with respect to people taking their first required minimum distributions. Let's talk about that April 1 deadline, who that is relevant for.

Slott: There's urgency there because we had this kind of relief, you may remember, in 2009. They waved RMDs, but they didn't allow this provision which they allowed in this bill. If you turned 70 and a half in 2019, your required beginning date ... you had to take your first RMD for 2019 by April 1 this year. Under this bill, that RMD is waived as well. So if you haven't taken it already, you don't have to. Matter of fact, you get a double benefit because anybody who didn't take it in 2019 would have had to take their first two RMDs in 2020, the first one for '19 and the second one for 2020. Now they're both waived.

Benz: Switching gears over to another provision that we expect to see in this package relates to early withdrawals from 401(k) plans. People will have some leeway if they have emergency expenses to take some money out of their 401(k)s without penalty. Let's talk about that.

Slott: These are provisions we saw in previous disaster-related tax acts. It's the same language we've seen before, only applied to this coronavirus catastrophe we're living through now. People that, say, were under 59 and a half could have access to their plan or IRA money penalty-free up to a $100,000. Now you don't automatically take $100,000. You have to prove what you need, obviously. If you only need $25,000, that's what you will be allowed to take. It will be penalty-free. Now, the key here is, remember it is still taxable. But what they did is they allow you to spread the tax bill over three years to soften the blow. So that's not a bad deal, and there's a repayment option. So if things turn around and you can put the money back in, you can eliminate that tax bill by putting the money back in.

But I have to say with this and the loan provision we're going to talk about, these should be last resort provisions. It sounds like it's a big help, and maybe it is, but only if this is the last place to go. The last thing you want to do, even if you get relieved of the penalty, is to pull money out of your retirement well before your retirement years and pay tax on that money. That money's going to be hard to replace. It took years, paycheck at a time, to put that money in. So I would think twice about that. It's a dangerous situation once you go down that road. Another problem I see: Let's say somebody needs $30,000, and they take $30,000 out. As I said before, they may not be thinking about the tax bill. If you need $30,000, you may have to take out $40,000 to net $30,000.

Benz: You referenced a loan provision. Let's talk about that.

Slott: The loan provisions, like in the other disaster bills, were relaxed. The difference between the loan and this hardship distribution, as I said: The hardship distribution is taxable, the loan is not. So that's a help if you can pay it back, but you end up in the same place with both of these. There are no freebies here other than the 10% penalty relief on that hardship distribution, because with the loans you have to pay it back. Now they give you a little bit of a grace period, but if you can't pay it back, it could turn bad on you. It could turn into a deemed distribution where you couldn't pay the loan back and now you're back with a tax bill, and these are not good strategies. They should only be used as the last resort, because you're undoing the whole purpose of your retirement account way too early.

Benz: I would agree with you on that front. Would you say, though, the loan is generally preferable to taking that hardship withdrawal and that the interest you pay on that loan goes back into your account?

Slott: Yes, and you might not even have a choice. There was a change in the tax law, but many old plans have provisions that say you first have to take the loan before you're even eligible for a hardship distribution.

Benz: I know you have been watching this area closely. You've been watching Congress over the past few days. Ed, thank you so much for summarizing what's going on there with respect to retirement and tax-planning consideration. Thank you for being here.

Slott: Thanks, Christine.