What the coronavirus relief package means for your 401(k) account
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On March 27, President Trump signed the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The $2 trillion relief package is the largest-ever of its kind.
You’ve likely heard of the CARES Act’s most prominent measure: recovery payments of up to $1,200 for most American taxpayers. But the 800-page law includes many other provisions, including some affecting retirement rules. If you have a 401(k) account, here’s what you need to know.
The COVID-19 outbreak has already shuttered businesses and entire industries. Over 3 million Americans lost their jobs in just a matter of days, leading to the country’s largest-ever spike in unemployment. This will force some people to prematurely dip into their nest eggs to pay for groceries, utilities, and rent.
The CARES Act makes it easier (and cheaper) to make a new type of withdrawal, called a coronavirus-related distribution. Specifically, the law allows individuals affected by COVID-19 to withdraw their entire account balance up to $100,000 without paying tax penalties, as long as they pay the income taxes owed on these amounts, within three years. Normally, hardship distributions are subject to a 10% tax penalty for early withdrawal.
Keep in mind that these relaxed rules only apply to individuals who meet any of the below requirements:
- They’ve been diagnosed with COVID-19.
- Their spouse or dependent has been diagnosed with COVID-19.
- They’ve experienced adverse financial consequences as a result of the outbreak.
The “adverse financial consequences” covered by the law include being quarantined, laid off, furloughed, or having your hours reduced. This includes anyone who needs to take time off to watch their children while schools and daycares are closed.
401(k) Plan Loans
Hardship distributions aren’t the only option for those who need emergency access to their savings. Although it is almost always better to rely on savings outside of retirement, account holders can also take 401(k) plan loans. These are what they sound like: a loan from one’s retirement account, paid back on a set schedule. Because loans are not considered distributions
no taxes are owed when the loan is issued. Interest rates and rules vary from plan to plan, but an IRS requirement that has stayed constant is that loans are capped at 50% of the borrower’s account balance or $50,000, whichever is less.
The CARES Act increases this maximum. Borrowers are now eligible to receive 100% of their vested balance or $100,000, whichever is less (if their plan permits these changes). What’s more, the law allows individuals who already had active loans or would like to request a new loan to defer payments up to a year. Later, we’ll cover why capitalizing on this change might not be the wisest move.
Required Minimum Distributions
Retirees are also impacted by the CARES Act. Under normal circumstances, the IRS requires individuals in their early 70s to begin drawing down their 401(k) accounts and pay taxes on these amounts. These amounts are called Required Minimum Distributions (RMDs). The CARES Act freezes this requirement for all of 2020, meaning retirees can let their 401(k) accounts sit untouched while COVID-19 market volatility runs its course. This enables seniors to leave money in the market, instead of drawing down when the balances are lower than anticipated, with the hopes that markets will rebound.
Retirees who depend on these distributions can continue receiving them without interruption. Oftentimes, RMDs are set to be taken out automatically on a set schedule. In cases like these, retirees who’d like to pause their distributions should contact their retirement providers to disable this setting.
It’s worth noting that this marks the second major change to RMD rules just this year. For an overview of how the SECURE Act impacted RMD age requirements, read our recap.
‘Last Resort’ Option
For millions of newly unemployed Americans, the CARES Act offers a much-needed lifeline. But while the law makes it easier for 401(k) account holders to use their money in times of need, doing so should be a last resort. Guideline’s own data suggests most investors have held off on making any drastic moves.
Why the reluctance? Taking any amount out of your 401(k) account, be it for a hardship distribution or loan, means losing out on compound earnings later on. Depending on your investment strategy and age, a withdrawal of $10,000 might mean missing out on $100,000 by the time you retire. While individuals aged 50 and older are allowed to contribute a little more to “catch up,” they don’t have as much time to see this compound effect run its course.
There’s also an element of risk, especially when it comes to 401(k) plan loans. If a borrower leaves their current job, and does not pay the loan off within a designated period of time, it will be treated as distribution — meaning the borrower will owe taxes, plus a 10% penalty if under age 59 1/2. Remember, the CARES Act raises the stakes by doubling the amount that 401(k) account holders can borrow. If an individual decides to take a loan for the new maximum ($100,000), an unexpected layoff or firing could result in a massive tax bill that puts them in even worse financial shape.
The CARES Act is already in effect. Retirement plans can adopt these rules today or in some cases, implement the new rules and adopt an amendment prior to 2022, even if they don’t currently allow for hardship withdrawals or loans. Companies should reach out to their retirement plan providers if they’d like to amend existing plan rules.
In order to support our participants through these unprecedented times, Guideline has expanded its services to include Coronavirus Related Distributions. Guideline has also undertaken development work to expand our 401(k) loan program to include increased loan amounts and payment deferments under the CARES Act loan provisions. To request or learn more about either of these options, we've created a cheat sheet to help you navigate this decision.
The last few weeks have been challenging for workers and financial markets. Millions lost their jobs and millions more have had to change their way of life. Market volatility has also left investors anxious about the state of their savings. Challenging as it may be, we encourage everyone to focus on the long term. If you can, hold onto those retirement funds. Your future self might just thank you.
The Guideline team will continue to monitor legislative and regulatory changes and adjust our retirement offerings to serve our clients and their employee participants.
Disclaimer: This content is provided for educational purposes only and is not intended to be construed as personalized investment advice. You should consult a qualified investment or tax advisor to determine the best course of action for you.