THE CARES ACT MAKES IT EASIER TO DIP INTO YOUR 401(K) ACCOUNT, BUT BE CAREFUL
With more than 16 million Americans having filed for unemployment relief in the past weeks, it’s likely that many in financial need will look next to their 401(k) retirement accounts for cash. The Coronavirus Aid, Relief and Economic Security Act (“CARES”), which allocates $2 trillion toward economic stimulus and relief in the wake of the coronavirus pandemic, includes several provisions that make it easier for those affected by the outbreak to access retirement funds- but be careful.
Prior to the enactment of CARES, the penalty for withdrawing from a 401(k) before the age of 59½ is 10% of the distribution, plus an automatic withholding of at least 20% for taxes. That all changes in 2020. Now, an employee can receive a coronavirus-related distribution from their retirement plan of up to $100,000 any time in 2020. These distributions are exempt from the 10% early withdrawal penalty and can be taxed as income spread evenly over tax years 2020, 2021 and 2022. However, if you can pay back the amount you took out within three years, you can claim a refund on those taxes. There also are changes to the rules for borrowing against retirement accounts. For someone who qualifies under the below requirements, the loan limit increases to up to 100% of his or her account balance or $100,000, whichever is lesser. Repayments are deferred for one year (although interest still accrues and is added to the loan balance) and extends the five-year repayment period by the amount of time that repayments were suspended.
To qualify for this type of distribution or loan, the employee must certify that either:
1. the employee, or their spouse or dependent, was diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention (CDC), or
2. the employee is experiencing “adverse financial consequences” related to COVID-19 as a result of:
- being quarantined;
- being furloughed, laid off, or having reduced work hours;
- being unable to work due to lack of childcare;
- closing or reducing hours of a business owned or operated by the employee; or
- other factors as determined by the Secretary of the Treasury.
Should I take a distribution?
Even with the new rules in place, it’s still advisable to exhaust most other resources, such as emergency funds or other accessible forms of savings, before tapping into your retirement accounts. But if you are considering taking a distribution from your IRA or 401(k), consider the following:
- Every distribution you take from your 401(k) or IRA today means less you’ll have for retirement.
- It’s a bad time to sell investments. In 2020, the S&P 500 had its largest first-quarter decline in history, finishing down 20% and markets may still be in the midst of a downturn. Pulling cash out of investment accounts after the market has fallen means you’re locking in any losses you’ve incurred and will you miss out on upcoming market rebounds.
- You’ll still owe income tax on your distribution from any tax-deferred retirement account. However, if you pay the distribution back within three years, you can file for a refund of the taxes you paid on that distribution.
Using cash from a retirement account should always be a last resort, but it may make sense to withdraw early to avoid high-interest debts or to avoid a risk of eviction or foreclosure from your residence. The key to minimizing the downside is to only take out what is absolutely necessary and, if possible, pay back the amount within three years — though the sooner you can pay it back, the better.
Farnsworth & vonBerg, LLP is continuing to monitor issues affecting clients and businesses in response to the coronavirus pandemic. If you have any questions, for more information on the topics mentioned above, or for assistance with addressing insurance issues, supply chain problems, development of best practices and protocols, or other matters affecting your business, please contact any of us here at F&V: email@example.com; firstname.lastname@example.org; email@example.com; firstname.lastname@example.org.
This publication should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer on any specific legal questions you may have concerning your situation.