The CARES Act, the legislation signed into law to help people affected by the coronavirus crisis, contains plenty of provisions for those saving for and living in retirement. The new rules apply to people, who have lost their job because of the pandemic, those suffering from COVID-19, or who have a spouse with the virus.
If you have no other resources but to touch retirement to provide temporary financial relief, it makes sense to use your 401 k if your emergency savings fund is also running low.
What has changed?
The law temporarily loosens the rules on hardship distributions from retirement accounts. People affected by the crisis can access up to $100,000 of their retirement savings without the usual 10% penalty.
The law also doubles the amount 401 k participants can take in loans from an account for the next six months to the lower of $100,000 or 100% of the account balance.
Things To Consider Before Make The Decision To Use Your 401 k
Make sure you check your portfolio before making the decision of withdrawing your money. If your 401 k has assets in cash or short-term bonds that have not been affected by the market decline, it may make sense to sell those investments in order to generate cash.
Make withdrawals without facing penalties
If you’re facing significant economic hardship and can’t afford to pay your bills, you may choose to tap your retirement fund. Typically, if you withdraw your savings from your 401 k or traditional IRA before age 59 1/2, you will have to pay a 10% penalty on the amount you withdraw. Under the new CARES Act legislation, you can now withdraw up to $100,000 from your retirement account without paying the 10% penalty.
However, under this new rule in order to avoid the penalty, your withdrawals need to be for coronavirus-related expenses. This means that to be eligible for these penalty-free withdrawals, either you or a loved one must have tested positive for the virus, or you must have experienced financial consequences due to job loss, reduced hours, or quarantine.
Just keep in mind that withdrawing from your retirement fund should be your last resort because it can potentially throw off the rest of your retirement plan. But if you’re out of options and desperately need the cash, this new rule can make it easier to access your savings.
You will be charged income tax on the withdrawal
You will need to pay income taxes on your withdrawals when you withdraw money from your 401 k or traditional IRA before age 59 1/2. According to the old rule, you were also subject to a 10% penalty. Even if you are eligible to avoid the 10% penalty by making coronavirus-related hardship withdrawals, you’ll still face taxes on the amount you take out of your retirement account.
However, if you are going through economic hardships you now have three years to pay income taxes on your distributions under the new regulations.
Don’t want to withdraw? You can borrow a loan from your 401 k instead.
In general, the rules surrounding 401 k loans are that you can only borrow up to $50,000 or half the amount in your retirement account (whichever is less), and you typically have to repay the loan within 5 years.
Under the new coronavirus rules, though, you can borrow 100% of your vested account balance up to $100,000. In addition, you’ll also have an extra year to pay back your loan. Keep in mind, though, that just because you can borrow this much doesn’t necessarily mean you should. Repaying your loan (with interest) could potentially put a strain on your budget over the next several years, so if you decide to borrow from your 401 k, only borrow the minimum amount you need to make ends meet.