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Home / Tips and Tricks / The CARES law has changed all the rules for 401 (k) withdrawals. Everything you need to know is here

The CARES law has changed all the rules for 401 (k) withdrawals. Everything you need to know is here

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Sarah Tew / CNET

In addition to giving Americans a one-time incentive payment and paving the way for increased unemployment benefits, the CARES bill temporarily changed the rules for withdrawing funds from retirement accounts. You can now make penalty-free withdrawals from your IRA or 401

(k) up to $ 100,000 without paying the usual early withdrawal fees.

With unemployment still high and millions of workers vacationing or working fewer hours than before, this important rule change could help provide urgent relief to the growing number of Americans financially affected by the COVID-19 crisis. Of course, it is possible to resort to pension funds if possible – but as the government continues to wrestle over the details of an additional stimulus package and other sources of funding dry upBorrowing from a retirement account can become an attractive option.

The new rules will remain in effect until the end of the year. Here’s how to use them.

Continue reading: HEALS, CARES, Heroes Acts: One last stimulus package could end up somewhere in the middle

What were the rules before COVID-19?

Prior to the passage of the CARES Act, you could not withdraw money from your retirement account until you were 59 1/2 years old without an “early withdrawal” fee. The 10% tax penalty was introduced to discourage people from spending money to save for retirement.

Though there were a few exceptions to the rule – like withdrawals for tuition and other educational expenses, or buying a home – Americans issued more than $ 5 billion in early withdrawal fees annually, according to the IRS. In general, to avoid getting hit by the penalty, it’s a good idea to leave your retirement account alone until you’ve stopped working full-time.

What has the CARES law changed?

The CARES Act allows you to withdraw up to $ 100,000 – with no penalty – from your retirement account by the end of 2020. So far, relatively few Americans have made use of this new exemption: The Investment Company Institute reports that less than $ 3% of retirement plan holders have made early withdrawals this year.

Continue reading: Did you lose your job Here’s what you can do with your 401 (k).

Who is entitled to the exemption?

Only deferred tax retirement accounts are affected by this exemption, including:

  • Employer-provided retirement accounts such as 401 (k) or 403 (b) – although other types of plans might apply

However, not everyone is entitled to this exception. You will only qualify if:

  • You, your spouse, or a dependent have been diagnosed with COVID-19.
  • You are experiencing major financial difficulties due to COVID-19, such as losing your job, late starting a new job, withdrawn job offer, vacation, reducing working hours, closing your company, or you can’t work due to inadequate childcare.

If you meet the criteria, you will have until the end of 2020 to make a qualifying distribution of up to $ 100,000 per person with no 10% tax penalty. Remember, while these would be penalty-free withdrawals, you still owe income taxes. But you can spread your debt over a period of three years.

Good reasons to tap your 401 (k) now

  • Money to cover urgent needs: If you need to make a mortgage payment, keep the lights on, or pay other bills, you may need to take money out of your retirement plan. If you are facing an eviction, lien on your home, or foreclosure, tapping your 401 (k) may make sense.
  • Avoid taking out a loan: If you have good credit and are eligible on favorable terms, taking out a loan can be a good short term tactic. But for many people afflicted by long-term unemployment and underemployment, a loan can simply become another impossible bill. Some people are not eligible for a loan and have no financial resources other than loans from their retirement plan.

Disadvantages of taking money out of your retirement plan

  • Take money from your future self: The standard advice is to leave your retirement account alone until you are retired. The sooner you start saving for retirement and the more you can contribute, the more it gets over time. Every time you withdraw money before you need it, you are taking money away from your future (retired) self. If you can avoid it, you should.
  • Tax implications: Even if you avoid the 10% early payout penalty, you will still be subject to income tax on that money. Remember: money deposited into a traditional IRA will be taxed when it is withdrawn – Not when it is contributed. Regardless of how much money you withdraw, your annual income will increase and you will be taxed accordingly. That could move you to a different tax bracket and change your tax liability dramatically.

Continue reading: 5 investment accounts everyone should have

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