IRA and 401K Withdrawals

IRA and 401K Withdrawals Made Easier During COVID-19

Key Takeaways

  • The CARES Act relaxes rules and restriction for individuals that need to access cash in their IRAs or 401-K retirement plans.
  • If you qualify, you can withdraw funds from your IRA without paying the 10% penalty, so long as you redeposit the funds within three years.
  • You can also stretch the time, up to three years, that you must pay the normal income tax due on the withdrawal.
  • The CARES Act also gives greater flexibility to employers who offer 401-K loans to their employees by doubling the maximum amount of the loans that can be made to 100$ of vested funds or $100,000 max.

Investing in Traditional IRAs and work-sponsored retirement accounts like 401-K’s are the most popular way to save for retirement. You can add money to accounts with pre-tax dollars, lowering taxable income, and accelerating compound growth. The challenge is that once you contribute to retirement accounts, any withdrawals prior to 59 ½ could be subject to a 10% early withdrawal penalty plus taxes.

New Rules for Accessing Retirement Accounts

The CARES Act implemented a relief valve for families short of cash who need access to additional financial resources to keep the bills paid.

In 2020, you can make a COVID-19 related withdrawal from qualified retirement accounts without paying the usual 10% early withdrawal penalty. You also have the choice to repay the withdrawn amount over a three-year period, which would eliminate the taxes owed on the withdrawal. It is also possible to spread the taxes owed over three years.

More Flexibility for Employers Offering Loans Against Retirement Accounts

In addition to penalty-free withdrawals, the CARES Act also gives employers more latitude on 401K loans. Previously, employers offering loans could allow employees to borrow up to 50% of the vested balance up to $50,000, with a 5-year repayment schedule. For 2020, employers can approve loans up to $100,000 or up to 100% of the vested balance, when a COVID-19 related hardship exists. To qualify, you must receive the funds by September 22, 2020, and meet the COVID-19 impact qualifications as defined by the IRS. While the list of qualifications is somewhat vague, and the IRS has commented they are considering further refining and/or expanding this list, some of the COVID-19 qualifications for preferential treatment of IRA withdrawals or 401K loans under the CARES ACT include:

  • You, your spouse, or a dependent test positive for COVID-19.
  • You experience adverse financial consequences due to being quarantined.
  • You experience adverse financial consequences due to being laid off, furloughed, or having your hours reduced.
  • You experience adverse financial consequences due to the closing or reduction of hours of a business you own.
  • Being unable to work due to a lack of childcare.

If you Need Access to Retirement Funds Should You Request a Withdrawal or a Loan?

A loan from a 401K is essentially borrowing money from yourself. Payments against the loan redeposit funds, replenishing the account over a five-year period. However, if you were to take the full $100,000, it would result in a $1,800 monthly payment.

There are two key downsides to a 401K loan:

  • A change in job status would require immediate loan repayment. At the cusp of a recession, when job insecurity is high, it might not be a good time to gamble on continued service with your current employer. You will pay 10% plus taxes on any unpaid balance.
  • Failure to repay the loan as scheduled will result in a 10% penalty on unpaid amounts.

The withdrawal feature not only waives the 10% early withdrawal penalty but allows you the opportunity to redeposit funds within three years if your financial circumstances change.

Loans are only available on work sponsored accounts. Traditional IRAs do not include a lending option.

Challenges to Early Withdrawals

Proof of COVID-19 Impact falls on you: The IRS requires you to document how you meet the qualifications for a COVID-19 related withdrawal to receive the funds penalty-free or qualify for the higher loan amount from your 401K.

Employer participation: Not all companies are implementing the new terms for 401K loans. Companies that do participate can also waive the automatic withdrawal of taxes on 401K withdrawals.

Loss of Compound Growth: When you use a long-term investment to cover short term financial needs, you lose the benefit of compound growth on those funds.

Final Thoughts

Saving enough money for a healthy retirement is based on a few fundamental principles: invest consistently over a long period of time and choose a wide range of investments to stabilize returns. Withdrawing funds early jeopardizes two of these three key elements. Even though you can take money penalty-free due to COVID-19, it is best to utilize this route only if there are no other options available.

Frequently Asked Questions

What are the new IRA rules in the CARES Act for 2020?

Under the CARES Act, congress eliminated the 10% early withdrawal penalty, allows you to repay the amount withdrawn to eliminate any income tax owed, and lets you spread out the tax liability on the withdrawals over 3 years.

What are the new rules for 401K withdrawals for 2020 under the CARES Act?

Under the CARES Act, Congress provided additional flexibility for businesses that offer their employees 401K loans by increasing the amount of the loan to 100% of vested funds, up from just 50%, to a maximum of $100,000, doubling the previous maximum amount of $50,000.

What are the COVID-19 qualifications to withdraw funds from a 401K or IRA without penalty?

  • You, your spouse, or a dependent test positive for COVID-19.
  • Adverse financial consequences due to being quarantined.
  • Adverse financial consequences due to being laid off, furloughed, or having your hours reduced.
  • Adverse financial consequences due to the closing or reduction of hours of a business you own.
  • Being unable to work due to a lack of childcare.

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