We find ourselves well into the coronavirus pandemic, along with its associated quarantines, social distancing guidelines, economic disruptions, and more than a few new rules to follow. As we all continue to adapt and adjust to these changes, now is a good time to clarify some of the retirement account provisions contained within the CARES Act passed by Congress on March 27, 2020.
Although this new law makes it easier to obtain penalty-free access to money held within individual retirement accounts (IRAs) and retirement savings plans at work (401(k), 403(b), etc.), there are several moving parts, and the new rules can quickly become confusing. As professional financial coaches, our team of CFP® professionals enjoys the unique opportunity to chat with people from all walks of life and help them navigate these turbulent times. Here are some frequently asked questions (FAQs) we encounter regarding these new rules and limits for accessing retirement money early to help with COVID-19 related situations:
Can I take out money from a retirement plan account for any reason?
No. Specifically, the CARES Act restricts this enhanced financial relief to only qualified retirement plan participants who have a valid COVID-19 related reason for accessing retirement funds early. Valid reasons associated with COVID-19 include:
- You, your spouse, or a dependent being diagnosed with COVID-19
- Layoffs, furloughs, reduced hours, or other inability to work
- Loss of childcare access
- You own or operate a business and had to close or reduce hours
What types of retirement accounts are eligible for early, penalty-free distributions?
Eligible retirement plan accounts include individual retirement accounts and annuities (IRAs), 401(k) plans (which include: qualified pension, profit-sharing, or stock bonus plans), qualified 403(a) annuity plans, 403(b) annuity contracts and custodial accounts, and governmental section 457 deferred compensation plans.
How much can I withdraw without penalty?
Under the CARES Act, an IRA owner or retirement plan participant who is under the age of 59 ½ may withdraw up to 100,000 from eligible retirement accounts for coronavirus-related events. If you are older than 59 ½, you already had the ability to take penalty-free distributions from these accounts. You might also be better off in the long run taking a loan from your retirement plan at work rather than taking a distribution (discussed below).
I have more than one retirement account. Can I withdraw $100,000 from each account?
No. The CARES Act restricts early distributions to $100,000 per person in total, regardless of how many accounts you use to withdraw funds.
Is there a deadline for taking coronavirus-related retirement account distributions?
Yes. These relaxed rules are in place through the end of 2020. The CARES Act waived the 10-percent early withdrawal tax penalty for coronavirus-related distributions made between January 1, 2020 and December 31, 2020. Unless new regulations are passed, the old rules regarding penalties for early distributions and maximum retirement plan loan amounts come back into play in January 2021.
Do I owe income tax on coronavirus-related distributions?
Yes, but you can spread out the tax payments over three years. You could also repay the money you took out of your retirement plan over three years and owe no income taxes or penalties. As with all tax decisions, it is a good idea to consult with a tax advisor before committing to this strategy.
Accessing the Different Types of Accounts
The rules for accessing money within an IRA or a former employer’s retirement plan are somewhat different from options that may be available in your current employer’s retirement plan. The following sections divide these options up accordingly.
Accessing money held in an IRA or a former employer’s retirement plan
Money held in an IRA or in your former employer’s retirement plan can only be accessed one way – through a withdrawal. Loans are not an option from these plans. If you are under the age of 59 ½ , the CARES Act provision for making a penalty-free withdrawal applies to you, if you are withdrawing money for one of the COVID-19 related reasons mentioned earlier.
I took an early distribution from my IRA / company retirement plan due to COVID-19. Can I put the money back into the account to avoid paying income taxes?
Yes, you can (but the clock is ticking). Ordinarily (in the BC era – Before Coronavirus), once you took money out of a retirement plan via a distribution, there was no option to put it back (other than a 60-day IRA rollover). However, if you take COVID-19 related distributions during 2020, the CARES Act allows you up to three years to recontribute the funds you withdrew to an eligible retirement account in the form of a rollover. More good news: The money you recontribute will not count toward the maximum contribution limit in the year these funds are contributed to a tax-deferred retirement account.
- Example: Selena was 48 years old when she lost her job in April 2020 because of COVID-19 layoffs at her company. She withdrew $100,000 penalty-free from her now former employer’s 401(k) plan to pay bills while she looked for new employment. In October 2020 she found a new job with a better salary and a generous bonus structure. Over the next three years, Selena deposited $33,333.33 each year into a traditional IRA as a rollover using a combination of salary and bonus dollars to “repay” the $100,000 she took as an early distribution from her old employer’s plan. As a result, Selena owed no income tax on this early distribution. She was also able to contribute up to $6,000 each year to a Roth IRA.
Accessing money held in your current employer’s retirement plan
If you are still working and need to take money out early from your current employer’s 401(k), 403(b) or similar retirement plan (due to COVID-19 reasons), you have two options for accessing up to $100,000 or 100% of your vested balance, whichever is smaller, in the form of a loan or as a distribution (withdrawal). But before you start making plans, the $100,000 loan or distribution limits for retirement plans are not automatic. You should check with your HR or 401(k) provider to find out what, if any, of the CARES Act provisions apply to your plan.
Suppose I take out a plan loan and repay it over time through payroll deduction?
This may be your most favorable option in the long run. No income taxes or early distribution penalties apply to plan loans (when repaid on time). The usual limit on retirement plan loans is 50% of your vested balance, up to a cap of $50,000. The CARES Act, however, temporarily doubles this amount for loans taken within six months of the CARES Act passage on March 27, 2020. Expanded loan limits will expire on September 23, 2020. Many plans give you up to five years to pay back loans, though plans differ. Check with your plan provider regarding the rules and timeframes for loan repayment where you work.
What if I just take a distribution (withdrawal) from my retirement plan?
Ordinarily, distributions are taxable, permanent, and subject to both income tax and a 10% excise tax if done prior to age 59 ½. The CARES Act suspends the 10% penalty, and taxes may be spread over three years. You can also elect to pay back the distribution into a tax-deferred retirement account (your plan at work or an IRA, for instance) within three years and owe no income tax on the distribution.
In short, if you need funds and must access your retirement savings, you are now able to take a distribution with fewer tax ramifications. However, if you think you might need to access your current 401(k), make sure to ask your employer if they are implementing that portion of the CARES Act before making plans.
Birkin, E. (2020). How the CARES Act Eases Retirement Account Rules During COVID-19. Forbes. Available at: https://www.forbes.com/advisor/retirement/cares-act-retirement-account-rules-covid-19/
Bischoff, B. (2020). Coronavirus stimulus-package tax relief: Withdraw $100K from your IRA — and repay in 3 years with zero tax liability. MarketWatch. Available at: https://www.marketwatch.com/story/coronavirus-stimulus-package-tax-relief-withdraw-100k-from-your-ira-and-repay-in-3-years-with-zero-tax-liability-2020-03-27
FedWeek. (2020). COVID-19 Stimulus Bill: Retirement Plan Changes Q & A. Available at: https://www.fedweek.com/issue-briefs/covid-19-stimulus-bill-retirement-plan-changes-qa/
Hopkins, J. (2020). 5 Ways the CARES Act Impacts Retirement Planning. Forbes. Available at: https://www.forbes.com/sites/jamiehopkins/2020/04/10/5-ways-the-cares-act-impacts-retirement-planning/#4cd80131676a
US Senate Committee on Finance. (2020). CARES Act Retirement Provisions FAQ. Available at: https://www.finance.senate.gov/chairmans-news/cares-act-retirement-provisions-faq