CARES Act: Penalty-free withdrawals

Individuals 09.09.2020 6 MIN READ

During this time of volatile markets, rising unemployment and economic uncertainty, many Americans are eyeing their retirement savings as a financial lifeline through the crisis.

The rules regarding early withdrawals from retirement accounts have changed this year for individuals affected by COVID-19, and you may be able to take a penalty-free distribution if you meet the requirements under the CARES Act. Here's what you need to know.

Early withdrawals: What’s changed

If you’re under the age of 59.5, typically a 10% penalty applies if you take withdrawals from your retirement plans.

However, under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, you may take COVID-19-related withdrawals of up to $100,000 from your retirement accounts on a penalty-free basis during 2020. You don’t have to take a single withdrawal—you can potentially take multiple withdrawals over the year as needed and it can come from multiple accounts (as long as the total doesn’t exceed the $100K limit).

You are eligible to take these withdrawals, if one of the following apply:

You've been diagnosed with COVID-19
Your spouse or a dependent has been diagnosed with COVID-19

You also qualify for these withdrawals if you’ve experienced adverse financial consequences due to COVID-19, including:

As a result of being quarantined, furloughed or laid off; having work hours reduced; being unable to work due to lack of child care; or closing or reducing hours of a business you own or operate
A reduction in your pay (or self-employment income) or a job was rescinded or the start date delayed
Your spouse or a member of your household was quarantined, furloughed or laid off; their pay (or self-employment income) was reduced; or they had a job offer rescinded or the start date delayed
A business owned or operated by your spouse or a member of your household either closed or had its hours of operation reduced

How does the IRS define “adverse financial consequences”?

The IRS has not yet issued guidance defining “adverse financial consequences.” This determination is highly dependent upon a subjective interpretation of the facts and circumstances of each situation. Therefore, if you take a withdrawal based upon what you believe constitutes adverse financial consequences, you could be at risk of a different interpretation by the IRS until clear guidance is issued.

Important caveats

You will need to check with your plan administrator or IRA provider to see if and how they are implementing these provisions and permitting these withdrawals. Also, it’s your responsibility to certify that you qualify based on the criteria described above.

These distributions are not subject to the 10% penalty that normally applies to early distributions. However, income tax will apply, although the law permits you to spread the income tax over three years, starting with 2020. You can elect to include the entire amount of income in this tax year if you wish.

Paying the money back

You may be able to recontribute the amount of these distributions back into an eligible retirement account any time during the three-year period after your withdrawal, potentially in a single transaction or multiple ones. Repaying these distributions won’t count against your annual contribution limits.

What will the tax treatment of a recontribution be?

First, any recontribution will offset the amount of the distribution to be included in federal gross income for the current year. If the recontribution exceeds the amount to be included in gross income in the current year, that amount can be carried forward or carried back. You will have the ability to choose either method. Carrying forward would allow you to offset income to be included from the distribution in a future year. Carrying back would allow you to offset income already included on a previous year’s federal income tax return from the distribution. Carrying back the offset will require an amended income tax return for the applicable year. In all cases, a recontribution must be reported on Form 8915‐E.

It is important to check with your plan administrator or IRA provider to confirm if and how they have implemented these repayment provisions. If you choose to recontribute funds, you should discuss the timing of repayment and the related tax consequences with your tax advisor or Ayco advisor.

Things to consider before withdrawing

The penalty-free withdrawal provision of the CARES Act was designed to help those with financial difficulties related to the coronavirus. If you qualify as a COVID-19 affected individual as described above, the law does not limit how you can use the distribution proceeds—for example, whether to pay medical bills, meet rent or mortgage obligations or address other financial needs.

But taking the money out of your retirement plan—even for a short period—interferes with your saving for retirement. Additionally, you may be selling some investments at a lower value due to the recent stock market volatility. Also, keep in mind withdrawing a large sum of money could result in meaningful income tax obligations, even if they can be spread over three years.

In these situations, consult with your Ayco advisor to discuss relevant considerations.

Withdrawal or loan?

The CARES Act also temporarily modifies some of the rules regarding 401(k) loans for COVID-19 affected individuals, to increase the amount that may be eligible to be taken as a loan and permit a one-year extension of certain repayment due dates. Again, you would need to check with your plan administrator to confirm whether it has adopted these changes under the CARES Act.

Before making a withdrawal or taking a loan, you will want to reach out to your plan administrator or IRA provider, as applicable. You can also reach out to your Ayco advisor if you have any questions.

For disclosures relating to this article, please click here.