Millions took early distributions from retirement accounts due to COVID

The Internal Revenue Service notified taxpayers last year about provisions of the CARES Act allowing them to take penalty-free early distributions from their 401(k) and IRA plans to provide relief during the COVID-19 pandemic, and millions took advantage of it, according to a new report that warned of potential noncompliance with the requirements.

The report, released Thursday by the Treasury Inspector General for Tax Administration, found the IRS took several steps to oversee the retirement-related provisions of the CARES Act, which Congress passed in March 2020. That included educating taxpayers and developing high-level compliance plans to enforce taxpayer compliance with the provisions. While taxpayers were allowed to take the distributions, there were various qualifications in both the CARES Act and IRS rules, including that the person or their spouse was diagnosed with COVID-19; that they were laid off, furloughed, had their work hours or pay reduced as a result of COVID; or that they were unable to work due to child care issues. A related provision of the CARES Act allowed taxpayers to delay taking required minimum distributions from their retirement plans after age 72 without penalty.

The report found the IRS informed taxpayers about the CARES Act retirement provisions through a number of avenues, and that IRS management developed compliance plans for Sections 2202 and 2203 of the CARES Act to assess the impact on examination activities and outline the steps necessary to efficiently encourage and enforce taxpayer compliance. The IRS developed a Section 2202 Compliance Plan to identify the risks associated with taxpayer eligibility for and reporting of early distributions and recommended training examiners and monitoring examination work for taxpayer compliance to determine if additional study is warranted. However, TIGTA pointed out that the Section 2203 Compliance Plan didn’t identify any risks associated with the waiver of required minimum distributions, but IRS management took steps to notify examiners about the provision.

The IRS headquarters in Washington
The IRS headquarters in Washington.
Andrew Harrer/Bloomberg

The report warned that many taxpayers didn’t follow the rules and could face potential tax penalties. “Millions of taxpayers took coronavirus-related early retirement distributions and will have corresponding requirements for reporting these distributions and paying applicable taxes,” said the report. “However, the IRS could take more steps to ensure that taxpayers comply with these reporting and tax payment requirements.”

The report pointed to disclosures from retirement investment companies and news reports indicating the extent of the early distributions during tax year 2020. Fidelity Investments, for example, reported at the end of the year that 6.3% of its participants (approximately 1.6 million people) took a coronavirus-related distribution, with an average distribution of $9,400. Vanguard reported at the end of tax year 2020 that 5.7% of its participants took a coronavirus-related distribution, with an average participant distribution of $24,600. In addition, Vanguard reported that 4% of its participants who took a distribution took the maximum amount of $100,000. The news publication Government Executive reported that 119,720 federal employees took $2.9 billion in COVID-related distributions from their Thrift Savings Plan accounts, an average of over $24,000 per participant.

To address potential noncompliance, the IRS is adding training on the provision to its examiners’ CPE training program, and plans to add information to its Knowledge Management and Transfer program to increase tax examiner and revenue agent awareness about coronavirus-related distribution risks.

TIGTA recommended that the commissioner of the IRS’s Small Business/Self-Employed Division make sure management has enough information available to help with compliance with Section 2202 of the CARES Act and consider creating a lead sheet to help IRS examiners when reviewing cases for potential noncompliance. IRS officials disagreed with both recommendations.

"We believe we have successfully implemented the CARES Act retirement provisions and that the IRS is positioned to effectively and efficiently identify and address noncompliance,” wrote De Lon Harris, commissioner of the IRS Small Business/Self-Employed Division’s Examination function, in response to the report. “In developing our compliance plans, we have drawn upon our experience with implementing similar relief in the wake of other natural disasters.”

Separately, the IRS recently extended another form of relief that was granted last year as a result of the pandemic, allowing retirement plan participants to sign documents remotely. Notice 2021-40 extends two types of relief from the physical presence requirement for participant elections to be witnessed by a plan representative or a notary public from July 1, 2021, through June 30, 2022.

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IRS TIGTA IRAs 401(k) Coronavirus
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