June 5, 2020

Who Can, And Should, Tap Retirement Accounts?

Who Can, And Should, Tap Retirement Accounts?


Part of the CARES Act allowed individuals to tap IRAs or 401(k) retirement plans if they were impacted by the coronavirus and needed cash. The law permits withdrawals up to $100,000 (or the account balance, if lesser), without penalty. The funds can be paid back, though it’s optional. For struggling business owners and workers, tapping retirement accounts may seem like a good option. But the provisions may not be available to everyone and those who can use retirement funds may be wondering whether they should.

The rules for tapping your IRA or 401(k) in 2020

Here’s a summary of the rules regarding distributions from retirement accounts if you’ve been affected by Covid-19:

  • Withdrawals are limited to the lesser of $100,000 or aggregated account balances across all IRA and 401(k)s.
  • You (the account owner), your spouse or dependent must have been diagnosed with Coronavirus or impacted financially because of the pandemic. This includes parents who couldn’t work because daycares weren’t open.
  • The CARES Act stipulates that while the coronavirus related distribution (CRD) is taxable as ordinary income, you can pay the tax over three years.
  • You have the option to pay back the money within three years and can file amended tax returns to recoup the tax already paid.
  • CRDs are exempt from the 10% penalty that typically applies to early withdrawals.
  • You can use the money for any purpose.
  • As of now, coronavirus related distributions are only in effect for 2020.

The IRS CRD FAQ page has further details.

Not all workers with 401(k) or 403(b) plans will qualify for coronavirus related distribution

Employer-sponsored retirement plans are optional benefits that companies can offer their workforce. Obviously, if you don’t have a 401(k), you can’t tap it if you need cash. But even if you do, you might not be able to take a coronavirus related distribution.

The CARES Act gave employers the option allow coronavirus related distributions and/or expand the terms of plan loan provisions to permit workers to take loans up to $100,000 from their 401(k). Until September 22, 2020, 401(k) plans can choose to increase maximum loan size from $50,000 up to the lesser of $100,000 (minus outstanding plan loans of the individual), or the individual’s vested account balance.

Employers decide whether to participate

Before Covid-19, employers could choose to adopt provisions to allow 401(k) loans within certain parameters. The key word here is choose.

Just as companies did not have to offer 401(k) loans pre-Covid-19, they aren’t required to include plan provisions to allow CRDs or expand loan limits. Modifying plan documents costs money, and in a time where employers have been suspending 401(k) matches or even terminating plans, they might not be inclined or able to do so.

Unfortunately, plan rules are one of the downsides to over-saving in a 401(k). If your asset mix is very heavily weighted towards retirement plans, consider broadening your investments to taxable brokerage accounts after you get back on your feet.

Ask your employer about the plan rules

If you’re still working for the company, ask your HR department about the plan rules for CRDs or 401(k) loans. If the plan sponsor doesn’t offer Covid-19 withdrawals, you may be able to take a loan instead.

Before taking a loan, make sure you understand the terms. 401(k) loans are essentially a loan to yourself that must be repaid to your account with interest. But if you leave your job, the full loan can be due immediately. Talk to your plan sponsor to learn more about the pros and cons.

Options for old 401(k) plans

If you have an old 401(k) plan, it could be an opportunity to do a 401(k) rollover to an IRA. The process is quite simple and may have other benefits too.

Should you take money from your 401(k) or IRA if you’ve been impacted by Coronavirus?

Tapping your retirement accounts shouldn’t be considered lightly. But depending on your situation, you may not have many other options. If your emergency fund has been depleted or you don’t have a non-retirement investment account, your IRA or 401(k) could your only liquid asset.

Think long and hard before using home equity

While using home equity could be an option, you may end up adding even more financial risk to your situation and could potentially lose your home if you fall behind. It also takes time and costs money to get a home equity loan or line of credit. If you’re already behind on your mortgage, tapping home equity likely won’t be an option.

What about credit cards?

Making minimum payments on credit cards typically works for a very short period of time. Interest rates are usually over 20% and the debt can compound quickly. Speak with your credit card company to see if there’s any leniency. Unless you just need to bridge a short gap between now and guaranteed future income, you might be better off using money from a retirement account. At least it won’t harm your credit.  

Stop saving towards other goals

It may seem obvious, but diligent investors are reluctant to stop saving towards other goals, even when faced with financial uncertainty. Before using money from your retirement accounts, consider temporarily freezing contributions to 529 college savings plans and other non-essential goals. If you have federal student loans, take advantage of deferred payments while they’re still available. Stop over-paying your mortgage.

If you’re in a financial emergency, try to do what you can to only put money towards expenses that must continue to be paid. Conserving now will make it easier to recover and resume good financial habits later.

If you take money from your retirement accounts

If you need to take money from your retirement accounts, make sure you only take what you need. Cut back on any non-essential expenses until you get back on your feet. Keep details records and work with a CPA to help ensure you file your taxes properly.

Tapping retirement funds is generally less risky if you’re confident you can pay it back. Otherwise, it could be a risk to your retirement. That said, if you need money for essentials today and have no other options, it sort of is what it is. Once you’ve recovered, you can work to cut back in other ways to catch up.



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