401(k) Updates Caused by the CARES Act

401(k) Updates Caused by the CARES Act

| April 15, 2020
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If you contribute to a 401(k), you’re probably aware of the strict rules around withdrawing money from this type of retirement account. However, some of these rules are currently being temporarily lifted thanks to the Coronavirus Aid, Relief and Economic Security (CARES) Act, which was enacted on March 27th. It is intended to be federal government support in the wake of the coronavirus public health crisis and associated economic fallout.

To qualify for CARES Act 401(k) provisions, you would have to fall into one of two main categories.

  1. You, your spouse or a dependent is diagnosed with COVID-19.
  2. You have experienced adverse financial consequences as a result of being quarantined, furloughed, laid off, having work hours reduced, being unable to work due to lack of childcare or closures related to the coronavirus pandemic.

Those who have a 401(k), especially those who are struggling financially due to the pandemic, should be aware of the changes caused by the CARES Act. Specifically, here’s what you should know about…

...taking a coronavirus-related 401(k) distribution.

  • Investors of any age can take out a coronavirus-related distribution of as much as $100,000 (or up to 100% of the balance) without paying early withdrawal penalties that those who are under the age of 59½ normally have to pay.
  • Your company's 401(k) plan sponsor will be the one to determine whether you meet the aforementioned qualifications for receiving this type of distribution.
  • Coronavirus-related distributions do not need to be repaid. However, if you take a coronavirus-related distribution and do not pay it back you will owe tax on the amount. You will then have three years to pay these taxes. This repayment does not need to be made all at once.
  • You could also choose to repay the distribution, within three years, without regard to annual contribution limits for your 401(k) plan. This repayment does not need to be made all at once. Any repayment would be treated as a "rollover contribution" to your 401(k) plan.
  • If you take a coronavirus-related 401(k) distribution and then get laid off or furloughed, you would not have to pay the distribution back. This is unique to this time of crisis because normally, if you take a loan from your 401(k) and then leave your company, many plans will require that the money be paid back immediately, or else it is considered a taxable distribution.
  • Any distribution made from qualifying retirement plans and individual retirement accounts on or after Jan. 1, 2020 can be considered a coronavirus-related 401(k) distribution.

...taking a loan from your 401(k).

  • The CARES Act has increased the maximum loan amount you can take from your 401(k). Previously, loans were limited to $50,000 or 50% of your balance. The relief act doubles the current retirement plan loan limit to the lesser of $100,000 or 100% of your balance.
  • 401(k) loans must be repaid.
  • To qualify, the loan must be made within 180 days after the enactment of the CARES Act.
  • Participants won’t owe income tax on the amount borrowed from the 401(k) if it’s paid back within five years.
  • If you’ve already taken out a 401(k) loan, your individual plan rules will be what determines whether or not you can take out another, even in this situation. It is not uncommon for retirement plans to limit the number of loans that may be outstanding at any given time. That being said, some plan sponsors are amending plans to allow for more loans in an attempt to assist with relief efforts.
  • However, if you qualify under the CARES Act and have already taken out a 401(k) loan, you may delay repayments due in 2020 for a year. Although, interest will continue to accrue on those deferred payments.

...taking a hardship distribution.

  • Most retirement plans already allow for hardship distributions, which are not the same as coronavirus-related 401(k) distributions. Hardship distributions are taxed in the year taken, cannot be repaid to the plan, and are limited to the amount necessary to meet a specific financial need. Because of those three differences, if you’re struggling due specifically to something coronavirus-related, taking advantage of the provisions provided by the CARES Act will most likely be more financially beneficial to you, especially in the long run.

...taking a regular minimum distribution.

  • This applies to individuals who have already hit retirement age. The CARES Act has waived minimum distributions [the required amount you must take out of your 401(k)] for the year.
  • Considering 2020’s required minimum distribution (RMD) number was calculated in 2019, when equity values were much higher, some experts suggest taking advantage of this by not taking a distribution this year. Of course, make sure you can afford to do this before making the decision.
  • However, if you have RMDs from an inherited IRA and already took distributions, you are not eligible to return the money back into the account.

...continuing to contribute to your 401(k).

  • If you are still getting a paycheck, you can still contribute to your 401(k).
  • Continuing to contribute to your 401(k), or even increasing your contributions, during this time is certainly something worth considering. The S&P 500 is down 27% from its peak so any new money you are able to contribute will be put to work at far lower valuations now than were available for most of the past two years.
  • For reference, the maximum 401(k) contribution for individuals in 2020 is $19,500, and the so-called "catch-up" contribution for employees aged 50 and up is $6,500.
  • Fair warning: there is nothing in the CARES Act that addresses whether or not employers have to keep providing 401(k) contribution matches. In general, employers can amend their 401(k) plans at any time. In this case, employers should promptly notify employees of any changes.
  • Also worth noting: if you’re being paid emergency sick leave or expanded family and medical leave under the Families First Coronavirus Response Act (FFCRA), those payments are eligible for salary reduction contributions to a 401(k) plan. 

Upon learning all of this, it can seem tempting to take out large sums from your 401(k), especially if your finances have been significantly affected by the pandemic. Overall, experts are cautioning to only take what you need right now and consider that you will still eventually need money for retirement. Plus, you could end up with a big tax bill when taking advantage of these relaxed rules if you don’t weigh all of the pros and cons carefully.

Withdrawing money from your 401(k) at any time does, to some extent, undermine the whole concept, which is that you are investing money over a long period of time so that the power of compound interest works in your favor throughout your employed years. This is also a rough time to have to liquidate stocks because the market is down nearly 30%. Because of these factors, many experts consider taking a distribution a “last resort.” This choice really is best in unique, emergency situations. If you need more help deciding what’s best for you, reach out to your financial advisor. 

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