When planning how to finance a large purchase before age 59-½, it is common to consider the idea of taking a loan from a 401(k) or taking an early distribution from a retirement account. Taking money from your retirement funds is not a decision that should ever be taken lightly, and it can come with undesirable consequences when it comes time to do your taxes or when it comes time to retire. But the Coronavirus Aid, Relief and Economic Security (CARES) Act has allocated $2 trillion for economic relief and stimulus, including provisions to make it easier and more sensible for some to access their retirement funds if necessary without penalty. 

If you are experiencing any hardships because of the coronavirus pandemic, to help get you through them, you might want to think about borrowing from your 401(k) or withdrawing money from another retirement account.

What Changed Because of the CARES Act?

Normally, you can withdraw or borrow up to 50% or $50,000 from a currently active 401(k) account before age 59-½. A premature withdrawal usually comes with a 10% penalty and at least an automatic 20% withholding for taxes.

Under the CARES Act, you can now borrow or withdraw up to $100,000 from employer-sponsored and personal retirement accounts, or a combination of the two. The 10% penalty is waived for distributions made in 2020 and there are no mandatory withholding requirements. However, if you do not pay back the amount you withdrew, the distribution will be taxed as income evenly over the years 2020, 2021, and 2022. If you pay back the amount within three years, you can claim a refund on any taxes which will have been paid. 

***Update*** (the loan provision section of the CARES Act was available up until September 22, 2020, unless Congress decides to extend this provision. If your plan allowed for normal loan provisions outside the CARES Act then those rules are now back in place.) You can also take out up to 100% or $100,000 as a loan and defer payments for up to one year. If you would like to learn more about what options are available to you, schedule a call with one of our advisors, who will be happy to review your options.

Who is Eligible? 

If you, your spouse, or a dependent has been diagnosed with COVID-19, you are automatically eligible. Otherwise, if you have suffered from any financial hardships due to the COVID-19 pandemic, you might be eligible. Several circumstances which impact either you, your spouse or a member of your household that has experienced one of the following:

• Furloughed, laid off, or mandatorily quarantined.
• Work hours were cut, income was reduced or a job offer was rescinded or delayed.
• Unable to work because of a lack of childcare.
• As the business owner, the hours of operation were reduced or the business was closed.

Even if you are still employed and you have had one or more of these hardships, you might be eligible for a distribution from your 401(k). 

Consider Your Options Carefully 

Consider the impact that a withdrawal from your account might have on compound interest over time. If you have no plan for paying it back any funds that you might have withdrawn, you may affect your retirement assets and your eventual retirement date instead of borrowing money from somewhere else. But, if you are experiencing hardship like loss of income, withdrawing money from your 401(k) might make more sense than accumulating high-interest debt that cannot be paid off in the near future. 

Be mindful of the impact that taxes will play in your specific situation. You can either claim your distribution as income all in the same tax year or spread the taxes out over the next three years. In most cases, it will be more beneficial to spread the income out, as you will be less likely to bump yourself into a higher tax bracket. Although, if you expect that your income will be substantially lower in 2020 than the two subsequent years, claiming the distribution all at once might result in a better tax situation. If you do not currently work with a financial planner and/or tax accountant, it could be highly advantageous to find one to help you file your taxes for 2020.

It is also important to know the difference between taking a distribution from your 401(k) and taking a loan from your 401(k). It might make more financial sense for you to take a loan if you plan on staying with your employer and paying back into your 401(k) within the next five years. A loan typically has a lower impact on your long-term retirement savings. But with a loan, repayment is required within a specific period - usually five years. The loan amount is not initially taxed and there is no penalty, but if you fail to pay it back within the loan period, you will be charged a 10% penalty fee. Also, if you leave your employer with an outstanding 401(k) loan balance, the remaining loan balance will come due soon after you leave. You can find that information in the loan provision documents on your 401(k) portal, if you do not pay the balance before this date, you will be charged for early withdrawal.

If you are having a tough time trying to figure out whether taking a withdrawal or taking a loan from your 401(k) is right for you, give us a call at (510) 200-8655 to talk with one of our financial planners to help figure out what might be your best course of action.

This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any federal tax penalties.