The CARES Act allows penalty-free 401(k) and IRA withdrawals for coronavirus costs.
THE CORONAVIRUS AID, Relief, and Economic Security Act allows retirement account owners to take withdrawals for emergency costs related to the coronavirus pandemic and partially delays the tax consequences. Workers will also be able to initiate bigger 401(k) loans and get a slightly longer repayment period for existing loans. Retirees can delay taking required minimum distributions from their depleted retirement accounts in 2020.
Here’s how to use your 401(k) or IRA for coronavirus costs:
- Retirement account participants can withdraw up to $100,000 for coronavirus expenses.
- The income tax due on a retirement account withdrawal can be paid over three years.
- Savers have three years to put withdrawn funds back in a retirement account.
- Retirees can delay taking required minimum distributions from retirement accounts in 2020.
- 401(k) loan limits increase to 100% of your vested account balance up to $100,000.
- The 2019 IRA contribution deadline has been extended to July 15, 2020.
Withdraw Up to $100,000 From a 401(k) or IRA for Coronavirus Expenses
Retirement savers who have been negatively impacted by the coronavirus crisis can now withdraw up to $100,000 from a 401(k), IRA or similar type of retirement account until Dec. 31, 2020, without being charged the usual 10% early withdrawal penalty. Those who are diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention or who have a spouse or dependent who tests positive for the coronavirus can take emergency retirement account withdrawals. Those who experience adverse financial consequences as a result of being quarantined, furloughed, laid off, reduced work hours or being unable to work because of a lack of child care due to the coronavirus pandemic are also eligible for the emergency withdrawals.
However, you will need to pay income tax on withdrawals from traditional retirement accounts and will be drawing from an account that has recently lost value without giving it time to recover. “While it may be tempting to take those penalty-free withdrawals and larger loan amounts, the same old advice applies: Find any other way to get by before you rob your retirement account. Not only will you be withdrawing funds at a greatly reduced share price, but your money could be ‘out of the market’ on those critical days during the market recovery,” says Andrea Clark, a certified financial planner for The Table Financial Planning in Fountain Hills, Arizona. “Slash your expenses, call your creditors about options and employ any other assets to get through this current crisis before also placing your retirement readiness in jeopardy.”
Pay the Income Tax Due on Retirement Account Withdrawals Over Three Years
Income tax will be charged on emergency retirement account withdrawals from tax-deferred accounts. However, the CARES Act allows you to spread the income tax bill over a three-year period, beginning in the year the distribution is taken.
You Can Put Withdrawn Funds Back in a Retirement Account
Retirement accounts are subject to annual contribution limits, which can make it difficult to rebuild your retirement account balance after you have taken an early withdrawal. However, those who take coronavirus emergency withdrawals can put the money back in a retirement account at any time during the three years after the distribution.
Delay Taking Required Minimum Distributions From Retirement Accounts
Retirees age 72 and older are generally required to take withdrawals from their retirement accounts each year. However, those who don’t need to withdraw money from their retirement account can skip their 2020 required minimum distribution. Retirees can now avoid taking withdrawals from depleted retirement accounts and give the stock market time to recover before resuming distributions.
“You only lock in a loss when you sell, and that loss can be very difficult to make up,” says Annelise Bretthauer, a certified financial planner and founder of Rise Up Financial in Hillsboro, Oregon. “If retirees can ride this wave without needing to take a distribution, I would recommend doing so.”
401(k) Loan Limits Increase
Participants in 401(k) plans are generally eligible to borrow as much as 50% of their vested account balance up to a maximum of $50,000. The CARES Act allows retirement savers to borrow 100% of their vested account balance up to a maximum of $100,000 during the 180-day period after the law is implemented.
“401(k) loans have to be repaid, most of them within five years,” says Denise Downey, a certified financial planner for Financial Trex in Spokane, Washington. “So, if you take $100,000 from your 401(k) as a loan, you will need to repay approximately $20,000 per year. That could present a cash flow strain in coming years.” 401(k) loans also charge interest and fees, and if you lose or leave your job, the loan could become due sooner than expected. Those with outstanding 401(k) loans that are due before Dec. 31, 2020, can delay repayments for one year.
Extra Time to Make 2019 IRA Contributions
IRA contributions must be made by the due date for filing your tax return each year. The due date for filing federal income tax returns has been postponed until July, so the deadline for making IRA contributions for tax year 2019 has been extended to July 15, 2020.
“It’s important to honestly assess what the next 90 to 120 days will bring with your employment and household cash flow,” Clark says. “It’s tempting to want to invest more when you have cash and everything is ‘on sale,’ but that window will remain open until July 15. If the economy begins to recover before that and your cash flow is healthy, by all means take advantage of this unique opportunity.”
If you are in the 24% tax bracket and contribute $6,000 to an IRA for 2019, you can reduce your federal income tax bill by $1,440. A new IRA contribution may be automatically applied to tax year 2020, unless you specify that it should be documented as a 2019 contribution.
If you took an early withdrawal from a 401(k) or IRA before age 59 1/2 in 2019, you were probably charged a 10% early withdrawal penalty. You can now delay the payment of a 2019 early withdrawal penalty until July 15, 2020, the new tax filing deadline.
Emily Brandon, Senior Editor | US News