Did you take money out from your retirement account because of COVID-19?

Older man receives help with taxes

It’s important that you let your tax preparer know if in 2020 you took money out of a retirement account (like an IRA or a 401K) because of COVID-19, especially if you took the money out before you turned 59 ½ years old.

Normally, people have to report all of their retirement withdrawals on their tax return, even if they already had tax taken out.  And if they took the money out before they turned 59 ½, then it’s called an early distribution and there is a penalty of an additional 10% tax. 

But, if you took the money out because of COVID-19, you don’t have to pay tax on all of it this year.  Instead you can spread it out evenly over 3 years.  For example, if you took out $9,000 because of COVID-19 in 2020, you could report $3,000 in income on your federal income tax return for each of 2020, 2021, and 2022.  Or, you can also simply report all of it on your 2020 return.

You need to discuss this with your tax preparer before filing the return, so that you can figure out if it is better for you to report all the retirement income on your 2020 return or to spread it out.  Your choice could affect things like the amount of Earned Income Tax Credit (EITC) you qualify for, and whether or not you have to pay back Advance Premium Tax Credits you got from the Marketplace to help cover your health insurance premiums. 

The IRS is also letting people repay COVID-related retirement distributions within 3 years to claim a refund.  That means if you report that whole $9,000 on your 2020 return, and you’re able to save it back up and return it to the retirement account within 3 years from when you took it out, you can file an amended return for 2020 to claim a refund of the tax you paid on it this year!

And, if you took the retirement money out because of COVID-19, and you were under 59 ½ years old, you can avoid the extra 10% penalty for the early distribution.

You qualify as having a COVID-related reason for taking money out early from your retirement account, and for the 3 year deals, if you took it out after: 

  • You were diagnosed with COVID-19;
  • Your spouse or dependent was diagnosed with COVID-19;
  • You experienced “adverse financial consequences as a result of being quarantined, furloughed, or laid off or having reduced work hours” due to COVID-19;
  • You experienced “financial consequences as a result of being unable to work due to lack of child care” due to COVID-19; or
  • You experienced “adverse financial consequences as a result of closing or reducing hours of a business that you own or operate” due to COVID-19.

The bank should have sent you a Form 1099R telling you how much you took out from your account and how much of that the bank withheld as tax.  You use the Form 1099R to prepare your tax return along with your other income information.  And make sure to save any records of how you were affected by COVID so you can provide them if the IRS asks!

More Resources
https://www.irs.gov/newsroom/coronavirus-related-relief-for-retirement-plans-and-iras-questions-and-answers 

https://www.irs.gov/newsroom/coronavirus-relief-for-retirement-plans-and-iras 

https://www.irs.gov/pub/irs-pdf/i5329.pdf