SIMPLE-IRA and SEP-IRA withdrawals offer relief from coronavirus financial impacts
Across the United States, the coronavirus crisis continues to affect the lives and livelihoods of millions of small business owners. In response to the health and financial emergency, Congress has passed the CARES Act, a $2 trillion relief package. While most coverage of the new bill focuses on its loan and tax-related relief provisions for small businesses, a lesser known part of the law can give you access to up to $100,000 by way of a penalty free withdrawal from your SIMPLE-IRA or SEP-IRA in certain circumstances.
If you’re a struggling small business owner who holds a SIMPLE or SEP-IRA, you might be considering dipping into these funds to make ends meet during this difficult time. In this article, we’ll walk you through the rules and considerations associated with taking a withdrawal from your SIMPLE-IRA or SEP-IRA.
Is it a withdrawal or more of an emergency loan from your SEP/SIMPLE-IRA?
First, we should clarify whether we’re talking about a withdrawal or an emergency loan. Where IRAs are concerned, you can really only take a withdrawal from your account. This is because “loans” from a SEP or SIMPLE-IRA are not permitted. Retirement account loans are typically associated with 401(k) Plans.
However, the penalty-free withdrawal provisions created by the CARES Act may seem like a loan as they let you take money out and pay it back to your account later. Let’s jump into the details of what the SIMPLE-IRA and SEP-IRA withdrawal rules entail.
Who can take SIMPLE-IRA and SEP-IRA penalty-free withdrawals?
The new law states that you can take a penalty-free distribution, up to $100,000 from your SIMPLE or SEP-IRA, if one of the following situations apply:
- You, your spouse, or your dependent is diagnosed with SARS-CoV-2 or the coronavirus disease 2019 (COVID-19).
- You experience adverse consequences as a result of:
- being quarantined, furloughed, or laid off or having work hours reduced due to the virus or disease,
- being unable to work due to lack of childcare due to virus or disease, or
- closing or reducing hours of a business owned or operated by you due to virus or disease.
How are you allowed to spend your SIMPLE or SEP-IRA withdrawal money?
Unlike other loan or borrowing programs available to small business owners, taking a withdrawal from your SIMPLE or SEP-IRA comes with no strings attached on how you spend it.
How soon do you have to pay back the money?
You have the option of not returning the funds back to your account. However, the distribution will be treated as income. Normally, you’d be taxed on the income the year you withdraw the funds. With the CARES Act rules, you’ll be able to spread the income from the distribution equally over three tax years.
So, no need to return it, right? Well, there’s an incentive to pay it back. Once you take the withdrawal from your SIMPLE-IRA or SEP-IRA, you’ll have three years from the day after the distribution date to return the distribution to your account. Follow that rule and your withdrawal ends up being tax free on top of being penalty free.
What else should you consider?
Normally, early retirement account withdrawals mean a 10% penalty. So, if you were to remove $20,000, you’d automatically owe $2,000 in penalties. The reason for the penalty is discouragement — plain and simple. Retirement investing works best when your money stays put, so the penalty is there to deter you from doing that.
Cashing out your SIMPLE/SEP-IRA dollars effectively unravels the tax-advantaged benefits the accounts are designed for. And, during this sharp economic downturn, it’s very likely, you’ll be selling any variable priced-based shares in your SIMPLE/SEP-IRA at a loss.
You could have tax and financial impacts beyond those mentioned above. For example, the additional income from your distribution could change your eligibility for income-based tax credits such as the earned income credit or the premium tax credit. What’s more, regardless of whether you’re considering retirement in the near future, a distribution now could impact your income stream in retirement.
Because of all these considerations, it’s important you check with your tax and financial advisors to find out how a distribution could impact your overall tax and financial situation.
Help for your SIMPLE and SEP-IRA withdrawal questions
While these considerations may curb your interest in taking an emergency withdrawal from your SIMPLE or SEP-IRA, we want you to be well informed of all aspects of your financial decisions. This is especially true during these uncertain times. Have questions about your personal or business taxes? Please know that H&R Block’s small business tax pros are here for you.