TAPPING INTO YOUR 401(k) DURING COVID-19
The coronavirus pandemic has reduced income to millions of Americans. As part of the CARES Act, Congress enacted special rules pertaining to early withdrawals and loans from tax-favored savings vehicles like 401(k) and IRA accounts.
Previously, an early withdrawal from a 401(k) or IRA was subject to a penalty of 10% of the amount withdrawn, and income tax was payable on the amount withdrawn.
New rules are available for early withdrawals taken through the end of 2020 and may also apply retroactively to withdrawals taken since January 1, 2020. However, retirement sponsors are not required to make these special withdrawals available. Taxpayers should check with their plan sponsors as to availability.
The special rules pertain to “coronavirus-related distributions” out of 401(k) and IRA accounts. A distribution is coronavirus-related if:
(i) the individual making the withdrawal, or his or her spouse or dependent, is 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, or
(ii) the individual experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off or having work hours reduced due to such virus or disease, being unable to work due to lack of child care due to such virus or disease, closing or reducing hours of a business owned or operated by the individual due to such virus or disease, or other factors determined by the Secretary of the Treasury.
- The withdrawal may not exceed $100,000 per participant
- The income tax on the withdrawal may be paid over three years beginning with the year the withdrawal is taken
- Typical 20% withholding for income tax purposes is reduced to 10%
- The withdrawal may be repaid over three years. Amounts repaid may let you avoid some or all of the income taxation. Also, amounts repaid will not be counted toward the usual annual contribution limits.
As with other elements of the CARES Act, further guidance is still to come, so some of these details may change. Taxpayers should make certain they understand exactly how their plan sponsor will implement these special rules.
Taxpayers are also cautioned that withdrawals from retirement accounts can substantially reduce the long-term value of the accounts because of the loss of compound interest. Many financial advisers recommend taking a loan from a 401(k) account before considering a withdrawal.
Loans from a 401(k) are a favored vehicle because the interest rates charged are usually relatively low, but more important, borrowers are essentially borrowing from themselves. The interest is paid back to their own accounts, for their own benefit in retirement.
Previously, a loan from a 401(k) account was limited to the lesser of $50,000 or 50% of the account’s vested balance. The loan is to be repaid within five years.
Now, the loan limit is doubled to the lesser of $100,000 or 100% of the account’s vested account. This doubling is permitted only for loans taken through September 23, 2020.
Employers have some flexibility in how they design their loan programs so once again, taxpayers should make certain they understand exactly how their loan will work.
For those who already have 401(k) loans with payments due between March 27, 2020, and December 31, 2020, the CARES Act extends the repayment period for one year. Interest will continue to accrue during the extension period. Loan payments thereafter will be adjusted to reflect the increased interest. This extension is an option; borrowers who still wish to make payments on time can still do so.
For further information please contact us at (845) 764-9656 or by email.
This is not intended to be legal advice. You should contact an attorney for advice regarding your specific situation.
Be sure to visit our Coronavirus Resource Page for more information.
Gary M. Schuster is partner at the firm and practices business, non-profit, and arts and entertainment law. He can be reached at 866-303-9595 toll free or 845-764-9656 and by email.