The Coronavirus, Aid, Relief, and Economic Security (CARES) Act was signed into law late last month. The vast sums of money being distributed under the CARES Act have received the bulk of the attention in the media, but this new legislation also makes a few noteworthy changes to some of the costly penalties tied to popular retirement plans. For example, when Americans reach their early 70s they must begin taking money out of tax-deferred accounts like 401(k)s and IRAs or risk facing a steep excise tax on the withdrawal shortfall.
For 2020, though, these required minimum distributions (RMDs) have been suspended as a part of the CARES Act, including the initial RMD that many retirees might have delayed from 2019 until April 1, 2020. This relief will not only help any older Americans unaware of the withdrawal requirement, but also those who do not want to be forced to take a disproportionately large taxable distribution at a potentially inopportune time. While the above change will enable some account holders to keep money in their plans longer, another CARES Act provision seeks to remove obstacles in the way of making withdrawals. Specifically, participants in 401(k)s and similar workplace retirement plans and IRA owners “affected” by the coronavirus can take an aggregate distribution in 2020 of up to $100,000 without incurring the standard 10 percent early withdrawal penalty as long as they pay back the funds within three years.
To be eligible for this relief, a plan participant or IRA owner (including a spouse or dependent) would need to either be diagnosed with SARS-COV-2 or COVID-19, according to Fidelity Investments, or experiencing adverse financial consequences as a result of an event, including but not limited to “quarantine, furlough, layoffs, reduced work hours, no available childcare, business closing or reduced business hours (self-employed), or other factors determined by the Secretary of the Treasury.” The CARES Act also significantly increases retirement plan loan limits and delays repayment requirements, but again such relief is intended only for individuals affected by the coronavirus. More details on these and other issues related to the CARES Act can be found here. Penalty-free access to one’s retirement assets may indeed help some households survive any direct and indirect financial hardships caused by COVID-19.
However, most financial advisers would likely agree that tapping into your 401(k) or similar account should only be used as a last resort because these plans are intended to help participants amass a significant retirement nest egg through a combination of consistent paycheck-to-paycheck contributions and the long-term resiliency of the market. This is especially true because even before the coronavirus outbreak, retirement account “leakage” was already a major problem. An earlier DCIIA survey, for instance, found that almost one in four Baby Boomers had cashed out their retirement savings at least once while changing jobs, and a third of younger respondents reported doing the same. Even more alarming, 42 percent of surveyed Millennials and a quarter of Gen-X respondents admitted that they spent their retirement plan cash outs on weddings, cars, and other non-emergency items.
More generally, another reason some Americans may be quick to tap into their retirement assets during the COVID-19 crisis is because they are not aware of the other support already provided by the CARES Act and related legislation. Such financial relief includes tax rebates for non-dependents and their qualifying children, a significant expansion of unemployment insurance, and forgivable disaster loans from the Small Business Administration that are even available to individuals who operate under a sole proprietorship (with or without employees) or as an independent contractor. Since the size of the relief can depend on income, state of residence, and other variables, consult with an accountant or other financial professional for more guidance on how the numerous provisions of the CARES Act may apply to your unique situation.
Sources: U.S. IRS, U.S. Treasury, Fidelity Investments, Barron’s, DCIIA
Post author: Charles Couch