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Should you make a 401(K) withdrawal for COVID relief?

The CARES Act reduces penalties for early 401(k) withdrawals, but using retirement funds can still cost you.

COVID-19 continues putting a strain on the global economy, with individuals and businesses feeling the pressure of lost jobs and wages. But even though the CARES Act made it easier for people to tap into their 401(k) plans without penalty, not many have done so.
Only 4.5% of investors took a coronavirus-related distribution between March and September, according to a Vanguard analysis of its retirement plan recordkeeping data. And the median withdrawal amount was only $12,000. But as uncertainty about the future of the pandemic drags on, you may be thinking about withdrawing money from your retirement plan.
Before you decide, know the risks of taking a bite out of your nest egg.

The CARES Act rules for your 401(k)

Under the CARES Act, the following changes affect how individuals can access 401(k) funds:

  • 401(k) withdrawals. Withdraw up to $100,000 from 401(k)s without incurring the standard 10% penalty. Distributions are taxed over 2020, 2021 and 2022 and if you repay the amount you withdraw in three years, you can claim a refund on taxes you paid.
  • 401(k) loans. Borrow up to 100% of vested balance up to $100,000 with no loan payments required during the first year. This applies if any repayment of the loan is due between March 27, 2020, and December 31, 2020
  • Waived minimum distribution requirements. Retirees can forgo their 401(k) distributions.
    You have until December 30, 2020 to take a coronavirus-related distribution.

Does it affect any other retirement plans?

Other retirement plans, including 403(b)s and individual retirement accounts (IRAs) are also included in the changes introduced by the CARES Act. You can withdraw up to $100,000 from 403(b)s and IRAs without penalty. Like 401(k) withdrawals, you can opt to have your distributions taxed evenly over 2020, 2021 and 2022, with the option to claim a tax refund on any amount repaid within three years.

More information: What is the CARES Act?

The Coronavirus Aid, Relief, and Economic Security (CARES) Act was passed by the US federal government on March 27, 2020 and provides over $2 trillion in emergency support for individuals, families and businesses affected by COVID-19.

Benefits of the CARES Act include:

  • Emergency grants and loans for businesses.
  • Relaxed unemployment and bankruptcy filing criteria.
  • Refundable tax credits for individuals.
  • Changes to how individuals can access their 401(k)s and IRAs.

What are the risks of using the CARES Act to borrow from my 401(k)?

Cashing out a 401(k) may sound tempting, especially in light of the changes introduced by the CARES Act. But withdrawing funds from your retirement savings comes with a number of drawbacks:

  • Loan repayment following a job loss. If you take out a 401(k) loan and lose your job, the window for repaying your loan shrinks. Instead of having six years to repay funds, you’ll have until mid-October of the following year to repay the entirety of what you borrow. And you’ll also be slammed with the 10% withdrawal penalty.
  • Lost interest. Funds in your 401(k) earn interest. For each dollar you withdraw, you lose a dollar — and then some due to compounding interest.
  • Locked-in market losses. The stock market plunged following the coronavirus outbreak. And while many sectors have recovered, many have not. Withdrawing money now instead of waiting for the market to recover means you lock in those losses. So while it might help to have money on hand in the short term, it’s important to think about the impact to your long-term strategy –– and a good time to talk to your financial advisor.

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Am I eligible to withdraw early under the CARES Act?

To be eligible for benefits under the CARES act, you must meet one of the following eligibility requirements:

  • You, your spouse or one of your dependents has been diagnosed with COVID-19.
  • You are unable to work because you must stay home to care for a dependent.
  • You have been laid off or have had your work hours reduced as a result of COVID-19.

How long does it take to get the money?

It may take several weeks before you see the requested funds in your bank account. Time frames for receiving money from your 401(k) depend on the account provider and payment method. Typically, 401(k) loan disbursements are available within a week of submitting an application, but the coronavirus outbreak has affected processing times for many providers.

Opt for direct deposit over a paper check to speed up the disbursement process.

Not many are using the option — so far

Vanguard data shows that only a small percentage of participants took a COVID-related withdrawal between March and September. But that number more than doubled from the end of May when less than 2% of investors took a coronavirus-related distribution. The median distribution amount also increased slightly from about $10,400 to $12,000.
Many people including you may be looking toward your nest egg for short-term financial security. But remember that tapping into your retirement plan now means you lose the benefit of future investment gains and compound interest. Stick to a strategy and speak with a financial advisor — and consider shopping around for low-interest personal loans.
You can also withdraw money from a high-yield savings account or brokerage account that’s not meant for retirement savings.

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