• Hugh F. Wynn

CARES Act Allows Emergency Withdrawals from Retirement Accounts

Provisions of the recent CARES Act – which offers both $1,200 cash payments and bonus unemployment benefits to workers – also makes it easier for retirement plan participants to take early withdrawals and/or loans from those plans for Covid-19-related reasons.

To qualify, individuals must fall into one of two main groups: If an individual, spouse or a dependent is diagnosed with Covid-19, or if a person can qualify by having experienced adverse financial consequences (i.e., due to being quarantined, furloughed, laid off, reduced work hours, etc., related to the coronavirus pandemic).


The legislation temporarily waives the 10% early withdrawal penalty, doubles the amount permitted for a loan from $50,000 to $100,000, doubles the percentage limit from 50% to 100% of the total account balance, and eliminates the federal taxes on such withdrawals if the money is paid back within a prescribed period of time… with strings. The legislation also waives 2020 Required Minimum Distributions from tax-deferred retirement accounts for folks older than 72. See my blog "Did You Know? You Don't Have to Take RMDs in 2020" (4/02/2020) for more details.


Strings Attached?

The CARES Act legislation temporarily waives the 10% early withdrawal penalty for taking early distributions up to $100,000 between January 1 and December 31, 2020, from tax-qualified defined contribution plans (401(k)s, 403(a)s, and 403(b)s, Section 457(b) plans and IRAs). Individuals have up to 3 years to re-contribute withdrawals to a plan. Income taxes will be owed on withdrawn amounts that are not repaid, but individuals are permitted to pay tax on this income over a 3-year period. In addition, COVID-19-related distributions are exempt from the mandatory 20% withholding that normally applies to retirement plan distributions.


Retirement plan loan rules are also modified. The maximum amount is increased for loans made between March 27, 2020 (the CARES Act enactment date) and December 31, 2020. During this period, the maximum loan amount is doubled from $50,000 or 50% of the vested account balance to the lower of $100,000 or 100% of the vested account balance.


Withdrawal or Loan?

The first decision a plan participant faces is whether or not to take advantage of this relief.

It’s a source of money – your money – but do you want to meddle with an important retirement account portfolio? Do you have a choice? If not, comes the second decision. Do you take out a hardship withdrawal or do you loan yourself money? What difference does it make?


At first glance, a withdrawal might appear to be the best course of action. It doesn’t have to be repaid, nor is an automated repayment system instituted. But if an individual can replace the withdrawn funds within three years (on no particular schedule), a tax refund is in order. A loan, however, must be repaid on a predetermined, fixed schedule. So, what’s the concern? History indicates that most folks tend not to pay back withdrawals from retirement accounts but are much more likely to make predetermined loan payments. Human nature, I suppose.


Consider it a Loan

If you absolutely intend to replace whatever amount you take out of a retirement account early, the loan approach might be the better choice. Why? Primarily because a fixed, repayment schedule makes repayment more probable. To qualify, the loan must be made within 180 days after the March 27 CARES Act enactment date. And the participant won't owe income tax on the amount borrowed from the plan if it's paid back within 5 years. Point is… if you don’t trust yourself to pay back a withdrawal or if your job is in serious jeopardy, go the withdrawal route. Otherwise, consider the loan.


Start with Half

Once you make the loan versus withdrawal decision, you must then decide how much to take out (within the guidelines of the amounts and percentages mentioned earlier). Often, the degree of need for immediate cash is unknown or at best nebulous. A rule of thumb might be to take out less than half of what you “think” you might ultimately require. You can always go back for more once your cash needs gain more clarity. Clear this approach with your employer or plan administrator ahead of time should there possibly be limits on multiple loans. This approach will help you least disrupt your retirement portfolio in case cash requirements prove to be less than initially thought.


Post-Crisis Plan

Once the crisis passes, individuals should reinstitute their former savings pattern as quickly as possible – and don’t forget that the crisis-related “missed” contributions should be made up. After the first year of re-enrollment begins, an individual can increase the annual savings rate by 2-3%, if affordable, until it reaches the revised 15% cap established by the 2019 SECURE Act. Employers can offer a safe harbor 401(k) plan with an automatic increase (or auto-escalation) feature that raises plan participants' contributions until they amount to 15% of pay (participants can opt out of such increases).


Hopefully, the Covid-19 dilemma will soon be resolved, but it’s especially important that individuals who withdraw or borrow money from retirement plans make wise decisions during the crisis – decisions that don’t create future financial stress, particularly of the sort that will negatively impact your quality of life in retirement.


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