Retirement

The CARES Act Lets You Access Retirement Funds, But Should You?

The CARES Act was an unprecedented stimulus package that provided wide-ranging financial assistance, from stimulus checks to funds for small businesses. One provision that hasn’t been discussed as much is the increased access to funds earmarked for retirement.

The CARES Act waives some penalties for withdrawing from a 401(k) or other defined contribution plan or an IRA. The bill also allows for enhanced plan loans. But should you take advantage of these provisions, or should you look for another solution during these tough economic times?

Here’s what the CARE Act says

Normally, you would have to pay a 10% penalty if you take funds from your retirement account before you’re 59 and a half years old. However, if you take what the IRS calls a “coronavirus-related distribution,” you can avoid that penalty. The CARES Act allows you to take out up to $100,000 from an eligible retirement plan.

Coronavirus-related distributions are allowed for those who have tested positive for COVID-19 and those whose spouse or child tested positive. Those who face “adverse financial consequences” due to the lockdowns and layoffs or being unable to work due to a lack of childcare caused by COVID-19 are also eligible.

Not all retirement plans will allow for coronavirus-related distributions, so you will have to check with your plan to see if it adopted the rules set forth under the CARES Act. If your plan isn’t offering coronavirus-related distributions, you may be able to qualify to have the penalty waived under one of the other financial hardship categories.

If you go that route, you may be able to treat those distributions as coronavirus-related distributions on your tax return if you can prove you meet the qualifications of those who suffered a hardship from the coronavirus pandemic.

Should you take the funds?

The COVID-19 pandemic has been tough on everyone in one way or another. Millions of Americans were laid off or furloughed. In the early days of the pandemic, Congress took care of these problems by rolling out unprecedented levels of stimulus, but more recently, the bipartisan spirit seems to have drifted away.

As a result, more and more people could find themselves thinking about tapping their nest egg just to make ends meet until things get better. Funding for small businesses to keep workers employed ran out, so there could be an uptick in unemployment in the coming weeks.

Whenever you’re dealing with anything that has to do with your retirement accounts, it’s important to look at all the implications of your decision. For example, if you’re pulling money out after the market has plunged, you are limiting the portfolio’s ability to grow and regain the value lost when the market crashed.

The market has recovered since the March selloff driven by the pandemic, so if you were going to take a distribution from your retirement plan, it would be better to do it now after the recovery and before another steep selloff.

Consider the tax implications

If you’re already thinking about taking money from your retirement account, it probably means things have gotten really bad. Pulling money from a retirement account should always be the last option, and this is no different during the ongoing pandemic.

Even though the coronavirus-related distribution exempts you from paying the 10% penalty, you will still have to pay taxes on the money. You can choose to pay all of the taxes this year or split the tax liability between this year and the next two years by reporting one-third of the distribution as income in each of the three years.

Either way, you should make sure to set aside a percentage of the distribution for taxes, so you don’t end up with a sizable tax bill when April rolls around.

Can you pay it back?

In some cases, you may be able to repay the distribution you take from your retirement account, and if it is possible, you should do so. To avoid paying taxes on the distribution, you must pay all of it back within three years of the date you took the distribution.

You can file amended tax returns for each of the previous two years if you finish repaying the distribution in the third year. This will allow you to claim a credit for the tax money you paid before you returned the distribution.

There is no right answer about whether or not to take a coronavirus-related distribution from your retirement plan. If you truly have no other options, it’s worth considering, but you must make sure you understand everything before you decide to do it.