What taxes will I owe on this COVID 401(k) distribution?

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Q. My wife was affected with COVID so we are seeking to withdraw from our 401(k). I was given the option to pay the federal tax of 10% at the time of distribution or delay it over three years. I elected to pay the 10% upfront, but what happens when I file my taxes?
— Trying to plan

A. We’re sorry to hear you and your wife have been affected by the virus.

Thanks to the CARES Act passed by Congress earlier this year, qualified individuals who were affected by COVID-19 are eligible to take a coronavirus-related distribution (CRD) under certain circumstances.

You are you are considered a qualified individual if you, your spouse or a dependent is diagnosed with the virus or if you experience adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced, said Joseph Sarnecki, a certified financial planner with U.S. Financial Services in Fairfield.

He said you are also considered qualified if you experience adverse financial consequences as a result of being unable to work due to lack of child care, or because of a closing or reduction hours of a business that you own or operate.

A CRD is a distribution that is made from an eligible retirement plan to a qualified individual from Jan. 1, 2020, to Dec. 30, 2020,up to $100,000 from all plans and IRAs, and it’s not subject to the 10% early withdrawal penalty normally assessed on those who are under age 59 ½, he said.

Although the distribution is not subject to the 10% penalty, is it still considered income taxable and will be added to your taxable income, Sarnecki said.

“The CARES Act allows this tax to be paid over a period of three years,” he said. “For example, if you take a $60,000 CRD, you have the ability to pay the tax on the full $60,000 in year one, or spread the income over three years at $20,000 per year.”

The ultimate tax that is owed is based on your income tax rate, Sarnecki said.

If you are in the 10% federal income tax bracket, and you paid this at the time of the distribution, then you should not owe additional tax, he said. But if you’re in a higher tax bracket, then you will owe additional tax,https://njmoneyhelp.com/2020/09/will-a-401k-withdrawal-put-me-in-a-higher-tax-bracket/ but you still have the option of spreading this over the three-year period.

Keep in mind, this will also be subject to New Jersey income tax, so you want to be sure you are prepared, Sarnecki said. He recommends you speak with your accountant to be sure you are planning properly.

“One other provision of the act is that it allows you to pay back the distribution over three years,” Sarnecki said. “If you choose to do this, you can file an amended return at that time and receive a refund for any taxes you may have previously paid.”

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This story was originally published Nov. 19, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.