Can you illustrate this tax treatment in an example?

A participant, age 35, takes a $30,000 plan distribution in 2020: 

  • Under normal rules, $6,000 (20%) would be withheld in federal income taxes, leaving only $24,000 cash available. In addition, there would be a penalty of $3,000 (10%) for withdrawing the amount prior to age 59½, and the participant would have to treat the entire $30,000 as taxable income in 2020
  • Under the CARES Act relief, the participant receives the full $30,000. The $3,000 penalty is waived, and she can include only $10,000 in taxable income per year for 2020-2022 tax years, which not only reduces the immediate tax burden but could also avoid moving her into a higher tax bracket.

Note: In Notice 2020-50 published on June 19, the IRS clarified that the default approach is to spread the tax liability ratably over three years, from 2020 to 2022. Individuals may elect to include the entire CRD amount on their 2020 tax return. However, once elected, the income inclusion method may not be changed.

Cetera Retirement Plan Specialists is a third-party administrator and may not offer tax, legal or investment advice. Plan sponsors should consult their own tax, legal or investment professionals.