Tapping Your IRA or 401(k) Plan to Weather the Coronavirus


In March, U.S. lawmakers passed a coronavirus relief and stimulus package to help Americans weather the economic shutdown.  The package includes changes to retirement plan rules to make it easier for people to take early withdrawals and loans from retirement accounts and IRAs.

Allowing such early withdrawals and loans may be helpful in providing cash for living expenses and avoid the need to tap into credit cards or personal loans to pay bills.  However, the downside of tapping into retirement plan savings is that by so doing the taxpayer may have some long-term detrimental impacts on their retirement.

Here are some of the highlights of the CARES Act provisions and other recent tax changes:

  • The law temporarily waives the 10% penalty on early withdrawals for Covid-19-related reasons. The waiver applies to distributions taken between January 1, 2020 and December 31, 2020. Up to $100,000 of distributions can avoid the penalty.
  • An in-service distribution from a qualified retirement plan such as a 401(k) also is permitted if it is coronavirus-related.
  • The mandatory 20% income tax withholding for rollover distributions is suspended during this period.
  • Income taxes on a coronavirus-related distribution can be paid over a three-year period.
  • The law eliminates the requirement to pay income taxes on such withdrawals if the money is paid back within three years.
  • The law doubles the maximum amount permitted for a plan loan, to $100,000 from $50,000, and doubles the percentage borrowing limit from 50% to 100% of the total account balance.
  • The law waives for 2020 the requirement that people take required minimum distributions from their tax-deferred retirement assets.
  • Since the tax return filing deadline for 2019 income tax returns was extended to July 15, the deadline for making a 2019 contribution to an IRA also is extended to July 15, 2020.

These changes are not mandatory.  Your IRA custodian or 401(k) Plan may have to be amended to permit these features so you should check with your Plan Administrator to see if these provisions have been included in your Plan.

To qualify for these IRA and retirement plan changes, a loan or distribution must be coronavirus-related.  That means the individual, the individual’s spouse, or a dependent must have been diagnosed with Covid-19.  Or, the individual must experience adverse financial consequences as a result of being quarantined, furloughed, laid off, or having work hours reduced due to Covid-19.  Also eligible are individuals who were unable to work due to lack of child care as a result of Covid-19.  An individual whose business was closed or had reduced operating hours as a result of Covid-19 also is eligible.  A retirement plan administrator can rely on an individual’s certification that he or she meets the requirements.

Deciding whether to take advantage of these options will require plan participants to balance pros and cons carefully.

An initial decision faced by participants who are forced to pull money from retirement savings is whether to take a hardship withdrawal or loan.  The loan approach does not have an immediate tax consequence but must be repaid on a fixed schedule.  This may cause difficulties if the participant is laid off or terminated.  The early withdrawal does not have to be repaid but will generate income tax obligations.  However, if the plan participant can repay it within three years, the participant may get a refund on taxes paid.

Most retirement plans currently don’t have automated repayment systems for repayment of hardship withdrawals like they do for loans.  Instead, workers will have to remember to send checks or payments on their own, and behavioral research tells us most are unlikely to do so.

For a participant who remains in service or anticipates promptly returning to employment, the loan approach may likely make more sense than the Covid-19 withdrawal.  For a participant who has separated from service and does not anticipate returning to employment, the Covid-19 withdrawal may be the superior option.

After deciding between a loan or a withdrawal, the next question is how much to take out.  A primary advantage of an IRA or 401(k) plan is that retirement savings are permitted to grow and compound on a tax deferred basis.   Withdrawals reduce the amount of tax deferred savings and, if not refunded, generate current taxation, leaving less for reinvestment.  It may make sense to take withdrawals of a little as possible and only when necessary.

Another decision is to whether to continue to participate in the Plan this year.  A participant suffering financial hardship from layoff or reduction in hours may want to scale back on making salary reduction contributions to a 401(k) or participating in an IRA.  However, bear in mind that scaling back a 401(k) contribution may reduce employer matching contributions.

The most difficult situation confronts plan participants who lose their jobs and become eligible to receive distributions from their 401(k) or other qualified plan as a result of separation from service.

As the United States seeks to reopen, plan participants who have felt the need to invade their retirement savings will need to focus on restoring their retirement accounts.  This may involve increasing future contributions to catch up.

In this situation, the separated participant faces a decision of whether to take a taxable cash distribution, make a rollover to an IRA account, or keep the account in the plan of the former employer.  The participant needs to consider closely whether to take the taxable lump sum distribution.  By taking a rollover to an IRA, the benefits of the tax deferral remain available.

Finally, there is a question for the retired participant to determine whether to skip their required minimum distribution for 2020.  This is most likely a question of whether or not taking the required minimum distribution is necessary to meet current living standards as well as the likely income tax rate in the current of future years.  If the taxpayer doesn’t need the money, there is an advantage to leaving funds in the retirement plan to grow tax free for the future.  If the taxpayer does need the money for support, then it may make sense to take distributions only as needed rather than an immediate lump sum distribution.

As can be seen, there are many variables and a wise participant will consult his or her financial advisor.  The attorneys at Perkins Thompson are also able to assist with your questions and can be reached at (207) 774-2635.