What to Consider Before Tapping Into Your 401(K) Under the CARES Act
With high unemployment rates due to COVID-19, many Americans find themselves in the position of having to make tough decisions. One of these important decisions is whether to tap into their 401(k) to cover expenses.
Because of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, those who have been affected by the pandemic may be able to:
- Withdraw up to $100,000 from employee-sponsored retirement accounts and/or IRAs without incurring the 10% early withdrawal penalty.
- Spread the taxable income on the withdrawal over three tax years. If you pay back the withdrawal, you can amend your tax returns to receive a refund and reduce taxable income.
- Take out 100% of your vested 401(k) balance as a loan up to $100,000. The payments on this loan can be delayed for up to one year. (This only applies if a 401(k) loan is available to you.)
Additional provisions are available to those who have been affected by COVID-19. According to the IRS, you are “affected” by COVID-19 if:
- You, your spouse, or dependent has been diagnosed with COVID-19
- You experience adverse financial consequence due to being quarantined, furloughed/laid off, or reduced work hours
- You experience adverse financial consequences because you’re unable to work due to lack of child care
- You experience adverse financial consequences resulting from closing or reducing hours of a business that you own or operate
Even with the additional provisions that allow you to access your 401(k), there are other factors when considering a withdrawal from your plan.
- Tax Consequences: The withdrawal is still taxable. You may amend your return when you pay back your loan, but there may be initial tax consequences to your withdrawal.
- Possible Delay in Retirement: Withdrawing from your 401(k) means that your invested assets may not grow as quickly. When you withdraw from your retirement account, you may lose some momentum in your returns from compounding and over a long period of time, it may have a large effect on your retirement balance. If you take a loan against your retirement account, prioritize paying it back as soon as possible to keep your retirement goal on track.
- 401(k) Loan vs. Withdrawal: If offered through your employer, you may want to consider a 401(k) loan rather than a withdrawal. With this strategy, you don’t need to worry about amending tax returns because the loan is not taxable when disbursed. However, you need to repay the loan to avoid the 10% early withdrawal penalty.
- Contact Your Plan Administrator: As with any withdrawal due to hardship, check with your plan administrator about the terms in your specific retirement plan.
The decision to withdraw from your 401(k) is not easy. The CARES Act allows more flexibility to those in need, but it still may be difficult to know if it is the right choice for you. Before you decide, consult with your financial advisor, plan administrator, and/or tax preparer.