The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was passed to bring financial relief for those impacted by the Coronavirus pandemic. In this post, we’re going to specifically look at the provisions for withdrawals from retirement accounts with penalties waived as well as the increased retirement plan loan limits.
Who is eligible to take advantage?
To benefit from the provisions outlined below, there are several ways to qualify:
- Testing positive for COVID-19
- A spouse or dependent who tests positive for COVID-19
- Suffered financial consequences because of quarantine (lost job, furloughed, reduced hours or unable to work due to lack of childcare)
- Experienced financial loss to an individually owned/operated business that is caused by closing or reduction of hours due to COVID-19
Changes to retirement plan withdrawal rules
If you qualify, the CARES Act removes the 10% early withdrawal penalty for those younger than age 59.5 for qualified retirement accounts for amounts up to $100,000. These rules apply to both employer plans (such as 401(k) and 403(b)) as well as individual retirement accounts (IRAs). The distributions must be taken by December 31, 2020.
Changes to retirement plan loan rules
The maximum loan limits from employer retirement plans has been increased from $50,000 (or 50% of vested balance) to $100,000 (or all of the vested balance). These loans would need to be initiated between March 2nd and September 23rd. It should be noted that not all plans allow loans, so these changes would not override a plan that does not allow for loans.
For withdrawals - tax withholding minimums have also been waived, though the withdrawals are still subject to taxation. However, you do have the option to pay the taxes due over a three-year period. If taking advantage of these benefits, it will be important to discuss tax planning with your accountant to comply with the rules.
For loans – there are not any changes to taxation of loans. Loans are not taxed, but rather paid back through payroll deductions.
For many, we think that the rules around withdrawals are more beneficial, but you should consider your situation as it will vary from person to person. One of the concerns of a loan is what would happen if you leave your job. For some (if not most) plans, the loan would be required in a lump sum. The lump sum would most likely come in the form of the loan simply becoming taxable (since payback would stop), however this would all be taxable. There is not a three-year spread of the taxes owed in this situation. The loan would have payments starting immediately so it could become a cash flow issue itself. For these reasons we would lean towards the withdrawal over the loan, but again, each situation will be unique.
Regardless of which you choose, the most important issue is accessing cash to improve your cash flow situation in the short-term. Long-term goals can be addressed later.
If you qualify to take a withdrawal but do not necessarily need to make a withdrawal from a cash flow perspective, we advise that you consult with your financial planner as each situation is unique. Generally speaking, if your income is not going to be significantly impacted in 2020, it is unlikely that a withdrawal would make sense for you.
Finally, it should be noted that you can re-contribute the amount you withdraw from your retirement account within three years (contribution limits would not apply). If you are concerned about the tax impact of the withdrawal or losing out on tax-deferred dollars that you worked hard to save, this is an important feature of the CARES Act.
The content provided herein is based on our interpretation of the CARES Act and is not intended to be legal advice or offer a tax opinion. This document is a summary only and not meant to represent all provisions within the CARES Act.