I had a 401(k) withdrawal. What’s taxable under the CARES Act?

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Q. I’m confused by how much of my distribution is taxable because of the CARES Act. I had a 401(k) plan through one employer and an $8,000 loan that I was repaying. I switched jobs in early June and took the distribution — about $55,000 including the loan — and the distribution did withhold taxes of about $11,000 as a full distribution based on rules before the CARES Act. I did put $25,000 into a separate 401(k) plan about a month later — so within the 60 days — so I know that is not taxable but $30,000 would be. Is there any way for that amount to be exempt?
— Still working

A. There are a couple of items to consider here.

First, the $25,000 that you returned to another retirement plan within 60 days should not be taxable to you because it would be considered a rollover, said Daniel Cocco, a partner with Beacon Wealth Partners in Nutley.

But you should be aware that you can do only one of these indirect rollovers per year, he said.

“Retirement plan distributions that are not rolled over are subject to ordinary income tax, so you would have to work with your accountant to see what your marginal tax rate is for that distribution,” Cocco said.

But let’s take a closer look at what happens because of the CARES Act.

“If this distribution is related to one of the COVID 19-affected reasons as deemed appropriate by the IRS, you can spread the taxable distribution over a three-year period, with claiming at least one-third of the income in this current year, 2020, and at least one-third in 2021, with the remainder of the income in 2022,” he said. “If you return more of this money into a retirement plan in 2021 or 2022, you can file an amended return to get the taxable income removed for the amount you paid back.”

You also have the option to claim the entire distribution in the current year, Cocco said.

Also, if the distribution meets one of the COVID19-affected reasons from the IRS, the 10% percent premature withdrawal penalty is waived is you’re under age 59 ½, Cocco said.

You can see more about the distributions on the IRS website. 

Also note these rules are for any distributions up to $100,000, so you would be under that amount and allowed to take advantage, Cocco said.

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This story was originally published on Sept. 9, 2020.

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