Earlier this year, the Coronavirus Aid, Relief, and Economic Security (CARES) Act became law. Designed to help us get through this difficult time, Uncle Sam's response to the pandemic contains provisions that temporarily make it easier for you to access your retirement funds.
If you've been impacted by the pandemic, this access comes in the form of increased borrowing limits from your employer plan or penalty-free withdrawals from an employer plan or IRA. Because these special loan provisions expired Sept. 23, I'll focus on the coronavirus withdrawals allowed by the CARES Act.
If you've already taken advantage of the change or are considering a withdrawal, here are some points to understand:
The eligibility rules are broad. You can make a coronavirus-related distribution or withdrawal if you or a family member have been diagnosed with COVID-19 or you've suffered adverse financial consequences because of the disease. The latter includes reduced work hours and not being able to work because you didn't have child care.
- It's temporary. As I write this, coronavirus-related distributions are available through the 2020 calendar year.
- Employers make the call. Your employer is not mandated to allow these coronavirus withdrawals, so check with your plan to see whether it is a possibility.
- It's capped. You don't have unlimited access to your retirement accounts. All coronavirus withdrawals are limited to a total of $100,000. For example, if you have both an IRA and a 401(k), your total withdrawal is capped at $100,000. Withdrawals above that threshold won't be eligible for the beneficial treatment discussed here.
- It removes key barriers. Typically, a pre-age 59½ withdrawal from a retirement account would trigger a 10% penalty. Likewise, a withdrawal from an employer plan would require 20% mandatory federal income tax withholding. Those penalties and withholdings do not apply with coronavirus withdrawals.
- There are special tax provisions. In addition to waiving the 10% early withdrawal penalty, you can elect to have the taxable portion -- yes, this part of the withdrawal will be taxed as ordinary income -- spread out over three years. A sit-down with your tax adviser can help you map out the best plan, based on your situation. It's important to remember that these withdrawals are not tax-free.
- It can be paid back. You can pay back the withdrawal by making a rollover contribution to your retirement account or IRA. Rules vary by employer, so it could be possible that when replacing money withdrawn from your 401(k), you would have to roll the money into an IRA. Furthermore, the replacement does not have to happen as a lump sum. You would recoup the taxes paid on the withdrawal by filing an amended tax return.
- There's an opportunity cost. Clearly, removing money saved for retirement should not be done lightly. Let's say you pulled $100,000 out of your 401(k) to help cover lost income or other pandemic-related needs. With 15 years and 7% growth until retirement, you will have shrunk your nest egg by around $276,000.
In the end, the call is yours, but it's one with serious near- and long-term implications.
Best of luck.