The Coronavirus Aid, Relief, and Economic Security Act” or “CARES Act” changed the rules regarding retirement plan withdrawals and tax penalties for 2020.
Here’s how the new law, also called the coronavirus stimulus package or H.R.748, could let you tap your retirement savings if needed.
Retirement plan distributions: Up to $100,000 penalty-free
Normally, distributions from qualified plans taken before age 59½ trigger a 10 percent early withdrawal tax penalty. This penalty won’t apply under special rules for coronavirus-related retirement plan distributions defined in Section 2202 of the CARES Act. These distributions must be made on or after January 1, 2020, and before December 31, 2020.
Not everyone qualifies, however. Qualified individuals include:
- You, your spouse, or your dependent were diagnosed with coronavirus by a CDC-approved test
- You are affected financially due to quarantine, furlough, layoff, or reduced work hours
- You are affected financially because you had to close or cut the hours of your business
- You can’t work due to lack of child-care
The law, however, does give the Secretary of the Treasury the authority to expand this definition.
If you are a “qualified individual,” up to $100,000 of distributions from your IRA or other qualified retirement plans made in 2020 are eligible for relief. The $100,000 distribution limit is aggregated between your IRA and other qualified plans.
CARES Act Retirement Plan Withdrawals
A withdrawal is different than a loan in terms of the repayment period and availability based on the type of retirement plan you have.
Withdrawals are the only qualifying distribution method available for IRA, SIMPLE IRA, SEP, and SARSEP account holders. 401(k), 403(b), and other qualified plan holders can decide between taking a withdrawal or a loan under the ACTs tax relief provisions.
If you qualify under the CARES ACT and you withdraw money from your IRA, 401(k), or other qualified retirement plan, you won’t have to pay the 10% penalty if you are under age 59 ½ that you would typically pay. Also, if you redeposit the funds within three years, you are able to recover the federal and state income taxes that applied to the withdrawal. To receive this tax-favored treatment, the distribution must be made in 2020.
Taxes will still be due on the amount withdrawn, if not repaid within three years, but any taxes owed can be spread evenly over the same three-year period. Repayments can be made in addition to the annual contribution limits.
CARES Act Retirement Plan Loans
The CARES Act doubles the amount a qualifying 401(k) participant can borrow to the lesser of $100,000 or 100% of the participant’s vested account balance; the current limit is $50,000. To qualify, the loan must be made within 180 days after the enactment of the CARES Act, which occurred on 3/25/2020.
You won’t owe income tax on the amount borrowed from your 401(k) if it’s paid back within five years. This differs from the three-year payback provision for withdrawals.
Qualifying individuals under the CARES Act who already have a 401(k) loan may delay repayments due in 2020 for a year. However, interest will continue to accrue on those deferred payments.
Q. Will these new temporary penalty-free withdrawal and loan options be automatically available in my 401(k) plan?
Not necessarily, these new temporary early withdrawal provisions under the CARES Act are optional, meaning your plan doesn’t have to permit them even if they already offer hardship withdrawals or loans. Check with your plan provider as to the availability of these options.
Q. What are the main differences between the CARES Act penalty-free withdrawal provisions and the existing penalty-free hardship withdrawal and loan provisions already available for my IRA, 401(k) or other qualified retirement plan?
The main differences between the CARES Act coronavirus related hardship withdrawal and loan provision versus the existing provisions already available include:
- For IRAs under the existing hardship withdrawal provisions, early withdrawal penalties are waived only for withdrawals prompted by a medically related hardship. If you don’t have medical insurance or your medical expenses are higher than what your plan will cover for the year. However, the amount available to withdraw penalty-free is the cost difference between the expense and 7.5% of your adjusted gross income.
- For 401(k) or 403(b)s the availability and qualifications for a hardship withdrawal are up to your employer who sponsors your plan. Although permitted by the IRS, employers are not required to offer them. If your employer permits hardship withdrawals however, the IRS rules govern whether or not the 10% early withdrawal penalty prior to age 59 ½ will be waived, as well as how much you’re allowed to withdraw.
- The amount withdrawn under the existing hardship withdrawal provisions for IRAs, 401(k) ‘s, 403(b) ‘s, or other qualified plan, cannot be paid back, and any taxes due are levied in the year of the withdrawal and cannot be spread out.
Q. What if I already have two loans out on my 401(k) or 403(b), which is my plan limit, will I be able to take an additional loan out under the CARES act?
Whether you can take out another loan from your 401(k) or 403(b) when you already have an existing loan will depend on your company’s plan’s rules, which are found in your plans Summary Plan Description (SPD).
Most retirement plans limit the number of loans that you are allowed to have outstanding at any time, and the CARES Act doesn’t automatically change such limitations.
If a plan allows for only one loan outstanding at a time, and you currently have one $25,000 loan outstanding, you would be unable to get another loan for the additional $75,000 that is available under the CARES Act unless your companies plan sponsor decides to amend the plan to allow for more than one loan. In light of the financial hardships the coronavirus crisis is creating for many individuals and families, some companies are beginning to look at making such amendments.
Q. If I took a $50,000 distribution from my retirement account back in January, is that withdrawal eligible for the CARES Act 10% Penalty waiver so long as I meet the appropriate qualification requirements?
Coronavirus-related distributions include those made from qualifying retirement plans and individual retirement accounts on or after January 1, 2020.
Keep in mind under what’s known as “the rule of 55,” 401(k) or 403(b) participants who leave their employer for any reason in or after the year they turn 55 are always free to pull money from their plan without paying the 10% penalty. This provision may not apply if you are furloughed
Lastly, although the relief provided by the CARES Act can be a critical lifeline if you need access to funds to get you through this challenging period, your ability to repay the amount withdrawn and other factors should be reviewed before making a withdrawal or loan. Speak with a fee-based financial planner first, who can help guide you as to all your available options and help you better understand the nuances of the CARES Act provision.
The information provided in this article is for general purposes only and should not be construed or used as tax, financial, investment, or other professional advice. If you have questions regarding your financial situation, you should consult your tax professional, financial planner, or investment advisor.