The Coronavirus Pandemic has thrown the personal finance strategy of millions of people into disarray. As a result, many Americans are considering whether to take early withdrawals or loans from their 401(k)’s. As part of the passage of The Coronavirus Aid, Relief, and Economic Security Act – or CARES Act – Congress outlined numerous changes to the laws governing 401(k)’s and other retirement accounts to help Americans struggling with their finances during this challenging time. Qualified individuals are now granted temporary exceptions to rules which often prevented them from accessing their money early.
The qualifications outlined in the CARES Act are broad. Anyone who fits into the following categories qualifies:
- You, your spouse, or a dependent is diagnosed with COVID-19.
- You experience “adverse financial consequences” as a result of COVID, such as reduced hours, being laid off, an inability to work due to lack of child care, or the reduction of hours or closing of a business you own.
Changes to Early Withdrawals and Loans
The first set of changes impacts withdrawals taken from retirement accounts before age 59 ½. The 10% early withdrawal penalty is temporarily waived by the CARES Act, as is the mandatory 20% federal withholding. Under normal circumstances, taxes on retirement account withdrawals would be due in the same tax year. The CARES act gives you the option to pay those taxes over 3 years. The deadline for CARES Act withdrawals is September 23rd, 2020.
The CARES Act also outlines changes to loans taken from 401(k) accounts. Loan limits have been raised from $50,000 (or 50% of account balance, whichever was less) to $100,000. Unlike a withdrawal, you will not owe taxes on the money borrowed, but you do have to pay it back. Loans taken under the CARES Act provisions no longer incur penalties as long as they are paid back within the loan’s time frame. Individual plans vary on the allowance of loans as well as the permitted length of loans. Remember, if you change jobs during the lifetime of a loan you may have to pay it back on an accelerated timetable.
Employers determine whether to amend their current retirement plans to meet the provisions of the CARES act. The important thing to remember is you may treat a distribution as COVID related even if your employer doesn’t. If you meet the criteria outlined above, you qualify.
Changes to RMDs
Required Minimum Distributions – or RMDs – are also waived for 2020 as part of the CARES Act. This can be quite a boon for those over age 70 ½ who have enough cash on hand to weather this storm. By waiving RMDs, the CARES Act allows retirees to avoid selling stock from their 401(k) during a tumultuous market.
Be aware that there are several disadvantages to tapping into retirement funds early. Experts agree early retirement withdrawals and 401(k) loans should be a last resort. If you can cover necessary expenses like rent/mortgage payments, medical bills/prescriptions, and food, it is best served exploring other options. Any money taken from your 401(k) early will adversely impact your retirement savings. With compounding returns factored in, even small withdrawals now can make a big difference later. If possible, explore withdrawing from a post-tax retirement vehicle like a Roth IRA to avoid paying taxes on emergency funds this year. While it’s not ideal to take early withdrawals from retirement funds, extreme situations can call for extreme solutions.
The information provided is for informational purposes only. It is not intended to be used, and should not be used, as the sole basis for legal and/or tax advice. Individuals should seek and rely upon the guidance and advice of their own legal and tax counsel before making any decisions regarding any planning, investment, tax concepts or strategies discussed herein. Individual circumstances may vary and results discussed are no guarantees of applicability or future performance.
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