Has COVID-19 negatively impacted your personal finances? Under the CARES Act, you can access the money in your 401(k) accounts to find some financial relief. But is this the right decision for you?
New Options in a New Norm
If you have been unemployed due to COVID-19, you are likely searching for financial assistance to help navigate a new normal. Though we saw a nationwide stimulus package in spring and will likely see a second stimulus package soon, you may need additional resources during this uncertain time. Legislators have responded to these unique circumstances by establishing new rules around early access to 401(k) funds. With the right pieces in place, tapping into your 401(k) savings could be a good option amid job instability.
Unemployment & The CARES Act
As unemployment surged, political leaders released the CARES Act to provide much-needed relief to Americans. Under this act, you can explore a number of options to help regain control if your finances have taken a hit due to COVID-19. Such options include early access to the money within your 401(k) account. To take advantage of this and withdraw some of your 401(k) money, you must provide proof that COVID-19 has negatively affected your personal finances. This includes evidence that:
- You, your spouse, or your dependant has been diagnosed with COVID-19
- You have experienced a layoff, furlough, reduction in hours, or inability to work (including lack of childcare)
- A job offer was rescinded or a job start date was delayed
- Your home experienced negative financial consequences
- Your or your spouse’s business closed or reduced its hours
In mid-June, the IRS published “Guidance for Coronavirus-Related Distributions and Loans From Retirement Plans Under the CARES Act” to help individuals understand available relief options, including examples of distributions and recontributions within the expanded rules. It is important to emphasize that early withdrawal is only allowed if you are under 59 ½ and can prove one of the above valid COVID-19 reasons behind your financial circumstances. Without that, the terms around your 401(k) remain the same as before the pandemic.
Early Withdrawal: What You Need to Know
If you qualify for early withdrawal, there are more details to understand before you take the next step. Here’s a brief overview of the most important points:
- You can withdraw up to $100,000 as a loan from your 401(k).
- Payments on this loan can be delayed for one year.
- The 10% penalty tax is waived for distributions made in 2020.
- There are no mandatory withholding requirements.
- Distribution can be taxed as income spread evenly over three tax years: 2020, 2021, and 2022. Note: You can claim a refund on those taxes if you pay back the amount you withdrew within three years.
Participants can borrow up to 100% of their vested account balance or $100,000, whichever is less. Keep in mind that 1) this only applies to loans made from March 27 to September 23, 2020, and 2) not all retirement plans allow for loans, so be sure to check your individual plan details.
Finally, if you have an outstanding loan repayment for 2020, you gain an extra year to pay back your loans. This creates a repayment period of six years with no additional payments due in 2020.
Is This the Right Option for You?
Although it could be advisable to take advantage of this opportunity and get early access to your 401(k) funds, there are many important considerations surrounding this decision. Even with the new rules in place, it’s still advisable to exhaust most other resources, such as emergency funds or other savings. Before tapping into your retirement funds, you’ll want to consider the following:
You may hurt your retirement.
Every dollar you take could contribute to damaged or delayed retirement plans, especially considering the effects of compounding interest.
You may be selling investments at a bad time.
The market remains unpredictable as COVID continues to spread across the country. Pulling from your investment accounts could mean you’re locking in any losses you’ve incurred. If that happens, you’ll have missed making gains even if you reinvest these funds at a later time.
You’ll need to remember taxes.
Keep in mind that you will owe income tax on distribution from any of your tax-deferred retirement accounts. If you pay that distribution back within three years, though, you can file for a refund on those paid taxes.
Of course, borrowing money from your 401(k) is not the most ideal short-term solution, but it can be better than adding credit card debt, losing your home, etc. If you are considering accessing your 401(k) retirement funds due to COVID-related joblessness, let’s talk about your options. At Wickham Financial & Insurance Services, our team specializes in creating effective, personalized financial plans. Working together, we can determine the right course of action for you and your situation.
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