The Cares Act and 401(k) plans in the US
The Cares Act affects retirement accounts by lifting some penalties for early withdrawal for those affected by COVID-19. Coronavirus-affected employees with 401(k) accounts will also gain easier access to their 401(k) early and be able to borrow higher amounts. Finally, those who have already borrowed against their 401(k) accounts will receive an extension of time to repay their loans.
Who is covered by the Cares Act?
The Cares Act defines your 401(k) or IRA transaction as "coronavirus-related" if the withdrawal or loan takes place between March 27, 2020, and Dec. 31, 2020, and one or more of the following is true:
- You are diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention.
- Your spouse or dependent tests positive for either of the above conditions.
- Your finances are harmed because you were quarantined, furloughed or laid off, or worked fewer hours due to the coronavirus pandemic or if you could not work because you could not get child care.
- If you are self-employed, you qualify if the virus caused you to close or reduce business hours.
- "Other factors as determined by the Secretary of the Treasury (or the Secretary's delegate)."
Anyone who tests positive counts as being coronavirus affected. Marc Lipsitch, a Harvard University epidemiologist, asserts that 40% to 70% of the world’s population could get infected. Dr. Brian Monahan, the attending physician of Congress and the U.S. Supreme Court, said he expects 70 million to 150 million people in the U.S. will become infected with COVID-19. The odds of testing positive, once testing rolls out in a big way, are relatively high. Even if you, like most people, only experience mild symptoms.
If you're lucky enough to evade the virus itself, there's a good chance that your bank account will not. Your earnings, whether you're a wage-earner or are self-employed, may take a hit. Your expenses could rise steeply — if, for example, you suddenly have to pay for child care because of school closures.
You may qualify under other disaster relief laws
Even if you don't meet the definition of a coronavirus-affected citizen, you might qualify for benefits under other disaster relief provisions. Many areas across the United States are under a federal COVID-19 disaster relief declaration.
- You can check the status of your state on FEMA's Disaster page. Search for your state in the drop-down menu and “January 2020” for the date of the event. You'll then see a list of links from most-recent declarations to less-recent.
- Check the IRS Page entitled Tax Relief in Disaster Situations for information. The IRS updates this page when new disasters strike and should start adding COVID-19 information soon.
Rule 1: Penalty-free withdrawals from IRAs and 401(k)s
The Cares Act waives the 10% penalty for early withdrawals from account holders of 401(k) and IRAs if they qualify as coronavirus distributions. If you qualify under the stimulus package (see above) and your company permits hardship withdrawals, you'll be able to access your 401(k) funds without penalty. The IRS will not consider this distribution a rollover, so your employer won't have to withhold 20% of the proceeds, either.
How do you claim your withdrawal? The Cares Act states that your employer just needs you to certify that you meet one or more of the eligibility requirements listed above. No one needs to look over your private health information or crawl through your finances to allow you to make a withdrawal under the Act.
Rule 2: You can spread taxable income from distributions over 3 years
You get two additional advantages if you make a coronavirus withdrawal from a retirement account in 2020:
- Typically, a withdrawal is taxed as income when you take it. If you withdraw $30,000, you have to pay taxes on $30,000 for that tax year. But the CARES Act allows you to spread out your taxes for the withdrawal over three years — 2020, 2021 and 2022.
- If you repay some or all of the distribution into your account, the IRS considers that amount a "rollover" and not subject to income tax.
Make sure that your plan allows you to access your 401(k) early for hardship withdrawals before undertaking a withdrawal.
Rule 3: Additional time to repay 401(k) loans
What if you already have a 401(k) loan? Usually, you have up to five years to repay it before the remaining balance becomes a taxable distribution and possibly subject to an early withdrawal penalty. The Cares Act won't change that five-year deadline, but if you qualify, you can suspend the payments that would be due on that loan from March 27, 2020, through Dec. 31, 2020, for one year.
However, interest will continue to accrue. Your employer may need to increase your payments at a later date to cover the additional interest and to make sure that you repay your loan during its five-year term.
What if your loan is due and payable because you have separated from your employer? If you have a loan against your 401(k) account and were supposed to pay it in full before Dec. 31, 2020, you get an additional year to repay it.
If any of these provisions apply to you, you must notify your employer.
Rule 4: 401(k) Borrowing limit doubled
Employees with 401(k) plans that allow loans can borrow twice as much as they could previously. This means they can borrow against $100,000 or 100% of their account balance, whichever is less. That's twice the old limit of the lesser of $50,000 or 50% of your balance.
You have 180 days from March 27, 2020, to borrow against your 401(k) under the Cares Act. And you'll also need to certify with your employer that you are eligible for the loan under the Cares Act.
Rule 5: IRS not requiring retirees to take minimum distributions
The IRS normally requires retirees in their 70s to withdraw money from tax-deferred accounts like 401(k)s and IRAs. And these distributions are taxable. The Cares Act waives those rules in 2020 because the COVID-19 pandemic has caused many of these balances to fall. Account holders can choose to skip the withdrawal and allow their balances to recover from the pandemic.
Your employer may not allow 401(k) loans or withdrawals
The Cares Act permits employers to make more generous loans or allow hardship withdrawals but does not mandate that they do so. Most of these changes really affect the Internal Revenue Code, not labor laws, so you'll need to check the fine print on your plan.
If your employer's plan does not currently allow for 401(k) loans or hardship withdrawals, the Cares Act does allow it to grant this relief to its employees and then amend its rules formally within two years. If you and enough employees speak up, your employer may decide to make your life a little easier.
COVID retirement loans and withdrawals: Should you take them?
Just because you can take an action doesn't always mean you should. The ability to tap into retirement funds early could be a lifesaver if you're out of work, out of credit and out of money. Borrowing against your 401(k) could allow you to reduce payments on things like high-interest credit cards. It might keep you out of foreclosure or allow you to put your family's health first by staying home more and working less.
However, tapping retirement funds might not be the best way to get through the COVID crisis:
- Hardship withdrawals, while not penalized, are still taxable. Consider this when deciding to take money out of your account early.
- Every dollar that you withdraw from your retirement is a dollar that won't be earning interest, dividends or growth. You're robbing your future.
- If your retirement dollars are invested in stocks, withdrawing when the market is down hits you even harder. You lose the opportunity to participate in the recovery that follows a recession.
- Borrowing against your 401(k) at least allows you to pay interest to yourself. But you have to suspend your contributions until you repay your loan. That's money that should be growing for your retirement. Remember that retirement account growth is tax-deferred, which helps it increase faster.
- Borrowing against your 401(k) if your job or industry is shaky might be a bad idea because you have a minimal time to pay it back if you lose your job after December 31, 2020.
If you must take from or borrow against your retirement, take as little as possible to limit the damage to your financial security down the road.
Alternatives to raiding your retirement
If you have emergency savings, now is the time to use it. Learn to live on less while the virus works its way through the country and the economy.
- Staying in should help cut costs like restaurant meals and going to bars with your friends.
- Consider suspending gym memberships, expensive cable packages (Hulu and others like it are surprisingly cheap) and phone plans.
- If you have multiple cars and are not going anywhere, call your insurance agent and ask about switching to a less-expensive plan for the cars not being used.
Ask for help if you need it.
- Contact your creditors (or have a reputable credit counseling service contact them) and negotiate lower interest rates and payments. Many will be happy to hear from you and know that they will be getting paid at least some of what you owe.
- Some of the largest mortgage lenders in the country have already announced plans to suspend payments for needy borrowers. Contact your mortgage lender right away to enroll in its plan if you're eligible.
- Talk to your landlord if you rent. Landlords today are anxious about who will and will not be able to pay their rent. Yours will probably be glad to hear from you and willing to negotiate some breathing room with you.
If you are lucky enough to be working and are concerned about emergency funds, prepare ahead of time. Save on your own and look for alternate ways of planning for an emergency. Lines of credit or credit cards (for emergency use only) may be good options because you only pay interest if you use the money.
You may be able to supplement your emergency fund with a personal loan, especially if you have excellent credit and solid employment. Or take a credit line against your home equity that you use only if necessary. Homeowners 62 and older with substantial home equity are probably eligible for Home Equity Conversion Mortgages (FHA reverse mortgages called HECMs), which could put cash in their hands even if they have little income and shaky credit.
The stimulus package contains many benefits, including the ability to access your 401(k) early. Evaluate your alternatives carefully before exercising that option and make sure it's right for your current and future situations.
Gina Pogol writes for MoneyGeek and is an acknowledged personal finance expert specializing in topics that affect consumers. A 25-year veteran in tax, mortgage, bankruptcy and investments, Gina enjoys breaking down complex financial topics to give consumers more confidence in their financial decisions.
Congress.gov. “Coronavirus Aid, Relief, and Economic Security Act (CARES Act).” Accessed March 27, 2020.
CNBC. “Up to 150 million Americans are expected to contract the coronavirus, congressional doctor says.” Accessed March 28, 2020.
TheHill.com. “Virus expert: As much as 70 percent of world's population could get coronavirus.” Accessed March 28, 2020.
IRS.gov. “Disaster Relief Bill Includes Retirement Plan Distribution and Loan Options.” Accessed March 29, 2020.
World Health Organization. “Naming the coronavirus disease (COVID-19) and the virus that causes it.” Accessed March 30, 2020.