Cares Act: New Rules for 401(k) Loans and Withdraws in a Covid-19 World (Catherine Collinson)
Well….we’re back with another edition of ClearPath – Your Roadmap to Health & Wealth. I’m your host, Al Waller. And…today, we’re going to discuss how the Coronavirus Aid, Relief, and Economic Security Act…..(otherwise known as the CARES Act) impacts loans and early withdrawals from 401(k) retirement accounts.
Now…for many who are short on funds or….facing emergency expenses due to COVID-19, the idea of taking a 401(k) loan or withdrawal may…. sound like an attractive life line…..however it can come at a long-term cost. Catherine Collinson, president of Transamerica Center for Retirement Studies is joining us to share her insights on the topic.
So Catherine..…as a point of beginning, could you please explain the impact of withdrawing funds before the CARES Act went into effect?
Catherine Collinson: Absolutely, Al. Before the CARES Act went into effect, taking early withdrawals from your 401(k) before age 59 ½ incurred a 10% penalty, a penalty designed to discourage such withdrawals. In addition to the 10% penalty, there’s a requirement to pay regular income tax on tax-deferred savings. At the time of the withdrawal, any amounts withdrawn are subject to mandatory 20% withholding for taxes.
Al: Yeah….and that’s a “pretty significant” slice off the top…. however as I understand it….The CARES Act does offer some relief for people facing coronavirus setbacks, right?
Catherine: Yes, for individuals who have been affected by COVID-19, withdrawals from their employee-sponsored retirement accounts are not subject to the 10% penalty and the mandatory tax withholding I mentioned before— and they have three years to pay the regular income taxes on tax-deferred savings.. On a different but related note, I’ll mention the CARES Act increases the maximum allowable amount for 401(k) loans to$100,000.
Al: Alright….now, you previously mentioned that only applies to those who have been affected by COVID-19. Can you elaborate more specifically on what those qualifications look like?
Catherine: Yes – and this is a very important point. The IRS clarified this to include anyone who has encountered “adverse financial consequences” due to COVID-19, ranging from being diagnosed with COVID-19 to job loss, furloughs, reduced hours, reduced income, to lack of access to child care. The intention is to help people who have experienced setbacks.
Al: Okay….now while I get removal of the 10% penalty sounds like a good thing, what are the drawbacks to taking a distribution or a loan from your 401(k) under the CARES Act?
Catherine: Even though the CARES Act makes it easier to withdraw funds from your 401(k), this option should only be used if absolutely necessary. At the end of the day, taking loans and early withdrawals can severely inhibit the long-term growth of your nest egg and jeopardize your retirement.
Al: Agreed…. So then before taking a loan or early withdrawal, what are some alternatives people should know and consider?
Catherine: Do your homework and learn what is available to you. For example, utilizing unemployment insurance and small business loans are two alternatives. If you are having trouble paying your bills, reach out to your bank and utilities companies to see what type of relief programs they offer. If all options are exhausted and you decide to take a loan or withdrawal from your retirement account, take only what you absolutely need and be diligent paying yourself back, so you can continue growing retirement savings.
Al: Well Catherine….Good to be with you again. And thanks, as always, for great research and your prudent insights. And of course we’ll be back to talk about this and other issues in the future. That’s all the time we have here today on ClearPath – Your Roadmap to Health. This is Al Waller on WYPR, your NPR news station. Stay safe & Thanks for listening.