Between the recent market volatility and the heightened health and safety concerns that many people are experiencing, it is natural and to be expected that investors have questions about their retirement accounts.
A few months ago, Congress passed the Coronavirus, Aid, Relief, and Economic Security (CARES) Act. This new legislation was created to help keep workers paid and employed, allow businesses to remain operational, make necessary health care system enhancements, and stabilize the economy.
One provision in the CARES Act includes a new type of distribution, called a “Coronavirus-Related Distribution,” designed to provide individuals with better access to their retirement accounts early. These accounts include defined contribution plans such as 401(k)s, 403(b)s, defined benefit plans or IRAs accounts. Coronavirus-Related Distributions may offer an individual a few potential benefits such as:
- Exemption from the 10% early withdrawal penalty if under age 59
- Taxable income from the distribution can be reported for taxes over three years
- Ability to repay any portion of the distributions up to three years after originally taken
- Exemption from mandatory withholding requirement on 401(k) distributions
- Opportunity to access funds in retirement plans which are typically limited while still working
What Are Coronavirus-Related Distributions?
Coronavirus-Related Distributions allow an individual to withdraw a total of up to $100,000 from retirement accounts such as a 401(k) or an IRA without having to pay a 10% penalty, even if they are under age 59. These distributions can happen anytime during the current year, 2020, and can come from a variety of an individual’s retirement accounts, totaling up the maximum amount.
What Determines If I Qualify?
An individual qualifies for the exemption in the following circumstances:
- They are diagnosed with COVID-19
- Their spouse or dependent is diagnosed with COVID-19
- They are experiencing adverse financial consequences as a result of being quarantined: furloughed, laid off, having work hours reduced, being unable to work due to lack of child care due to COVID-19, closing or reducing hours of a business owned or operated by the individual due to COVID-19, or other factors as determined by the Treasury Secretary.
What Can I Do?
There are no restrictions or limitations on how these distributions can be utilized. These withdrawn resources can truly be used for any purpose: catch up on late bills, provide financial assistance to your children, or to fund that overdue kitchen remodel. However, it is important to note that if an individual is not strapped for cash, it may be a less than ideal time to pull funds out of any retirement account with the markets declining the last few months. Typically, these accounts are long-term focused and therefore any withdrawal may affect your future retirement goals and plans.
How, When, and If I Will Be Taxed?
While the distribution will be subject to income taxes, as with any retirement account distribution, the tax liability with the CARES Act can be spread out over the next three years. Additionally, the individual will be able to recontribute the money back into the account over the next three years to avoid those income taxes. Regardless if the individual recontributes any money at all, they will not be on the hook for the 10% early withdrawal penalty.
For any distributions from a 401(k), normally there is a mandatory 20% withholding requirement sent directly to the IRS for pre-payment of income taxes. However, Coronavirus-Related Distributions are exempt from this requirement.
Parting Thoughts
It is important to remember that when money is withdrawn out of retirement accounts, one is locking in investment losses. Often, steep market downturns are followed by sharp market recoveries. By the time one recontributes any distributions, the upside recovery may be missed - making losses even worse.
Tapping into a 401(k) account should be one of the last resorts considered, after all other options have been exhausted. If an individual is behind on any debt payment such as a mortgage or car loan, reach out to the lenders to see if payments can be postponed. Given the current low interest rates, a homeowner can consider using its equity with a home equity line of credit. If an individual plans on recontributing any distributions, perhaps taking a loan against your 401(k) may be a more advantageous option.
Managing money in the middle of a pandemic can be an unprecedented dilemma. At the end of the day, the choice to use retirement account savings depends on many factors and it is important to review one’s entire financial wellness to understand what are the very best options.
The information provided here is for general information only and should not be considered an individualized recommendation or personalized investment advice.
The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There can be no guarantee that strategies promoted will be successful and no guarantee of positive results.