The coronavirus has created some interesting situations around money and managing investments, one of which is the CARES Act. The CARES Act (Coronavirus Aid, Relief, and Economic Security Act) includes a number of ways to help retirement savers find relief in an economically turbulent time.
A few benefits of the CARES Act include… Required Minimum Distributions (RMDs) for 2020 have been suspended and if you’ve already taken a distribution, you may be able to return it. Loan repayments from workplace retirement plans could also be delayed.
Additionally, the IRS has relaxed the rules around early distributions of retirement plans. The 10% penalty is waived for “coronavirus-related distributions” of up to $100,000 in 2020 if you take the distribution before age 59.5. This includes both IRAs and 401(k)s, as well as 403(b)s, 457(b)s, and similar tax-deferred plans.
Coronavirus-related distributions apply to individuals or spouses who have been diagnosed with COVID-19 or have been financially impacted by COVID-19. This includes if you’ve been furloughed, had to quarantine and miss work, being laid off, or having your hours reduced.
With all the current financial uncertainty, it’s possible that you may want to take advantage of withdrawing funds from your retirement savings. The flexibility to take pre-tax money without penalty doesn’t come along often. Further, 10% is a significant amount that’s being waived.
However, please don’t take an early distribution simply because the penalty has been waived. If you are considering withdrawing from your retirement funds with the benefits from the CARES Act, keep these three things in mind.
When assessing whether or not to take a penalty-free distribution of your retirement savings as part of the CARES Act, think about your short-term needs in relation to your long-term goals. In particular, remember that this decision could significantly impact said goals and the amount you have available to you in your retirement.
If you want to retire comfortably at 67, you’ll want to have a minimum of 9-11 times your salary saved. Depending on the amount that you take out now, that could interfere with your long-term financial goals, especially if you are currently close to retirement age.
It could certainly be to your advantage to leave your retirement savings alone for another year, especially with market volatility and increasing uncertainty about investment dividends. That way, you have another year for your investments to recover from the downturn the market is experiencing in 2020.
If this is truly an emergency and your short-term needs must be met quickly, look at other emergency savings first before dipping into your retirement fund, even if the CARES Act does waive that 10% penalty.
Tapping into your retirement savings should be a last resort. After all, these are planned savings for retirement, not a financial catch-all safety net. Before you consider taking funds from your retirement plan, cut your budget and household expenses, look into mortgage forbearance, or draw down on a personal line of credit. See what you can do with money more readily available to you right now.
If you absolutely must access this money from your retirement savings, create a plan to reasonably “pay back” this money within three years (more on that further down).
Just like ordinary income, there is still tax on the distribution if you choose to take advantage of the penalty-free access to your retirement funds from the CARES Act. These taxes may be paid back over a period of three years. You may also repay the amount withdrawn over three years in addition to your regular yearly contributions.
While the tax impact is lowered (ie: you have three years instead of one to pay the income taxes from money gained from your retirement funds), it’s still wise to consider your long-term goals and how this additional tax and repayment will affect your current plans.
Taking an early distribution of your retirement plan or other consideration afforded to your savings thanks to the CARES Act must be a carefully calculated decision. If it’s truly an emergency or it’s part of your broader plan, such as managing funds during a divorce so you don’t walk away with debt, having the penalty waived could be a relief. That said, it could also hamper your retirement plans and other long-term financial goals for the future. Talk to a financial advisor to see how taking this money today will affect your long-term savings or schedule a complimentary consultation to talk about your investment and retirement plans.