Accessing retirement accounts in a time of uncertainty

Americans entered the year with a great economy, low unemployment, and anticipation of continued economic success.  The unemployment rate reached lows not seen in decades and Americans were feeling confident. As Valentine’s Day approached, rumors of a virus in China started to hit mainstream media.  Shortly after, the market started to decline, and the first case of COVID-19 was confirmed in the United States.

As the Coronavirus spread, stay-at-home orders were put into place, the stock market crashed, and weekly unemployment claims spiked to record highs. With unemployment in double-digits, and layoffs surly to follow into the summer, Americans are scared.  For those unemployed, there are still obligations to pay.

As fear gripped Americans, Congress passed the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).  This bill provided checks to Americans under certain income limits along with help to small business owners.  The CARES Act also altered the distributions rules to make it easier for people impacted by COVID-19 to access retirement accounts. In a time of uncertainty, knowledge will help guide important decisions of many Americans faced with tough decisions. As Plato said, “Human Behavior flows from three main sources: desire, emotion, and knowledge.”

Standard rules

Previously, investors taking money out of retirement accounts (401(k)s, IRAs, 403(b)s, ect.) prior to age 59 and a half would face ordinary income tax, along with a 10% tax penalty on the amount of withdrawal in the year of the distribution. Within an Individual Retirement Account (IRA), there were a few limited exceptions to the 10% tax penalty including first time home purchase, higher education expenses and disability — to name a few.  Most 401(k) accounts are only available for withdrawal after separation from service.  A loan may be available from a 401(k) account whether still employed or no longer working, up to $50,000 or 50% of the accumulation, whichever is less.

Eligibility for relaxed rules

Under the CARES Act, distribution rules were changed in favor of investors impacted by COVID-19 to make it easier to access retirement accounts with a lower tax burden.  To qualify for the relaxed rules, qualified participants must demonstrate they were diagnosed with coronavirus, had a spouse or dependent diagnosed, or experienced a layoff, furlough, reduction in hours, or were unable to work due to COVID-19, or experienced a lack of childcare because of the virus. Without a valid COVID-19 related reason, the standard rules will apply.

CARES Act relaxed distribution rules

Under the CARES Act, Americans who qualify can take up to $100,000 out of eligible retirement accounts in 2020 without paying a 10% early withdrawal penalty. The act also suspends a mandatory 20% withholding that usually applies to distributions from employer sponsored retirement accounts. Investors will still owe ordinary income on IRA distributions, but a great amount of flexibility is given to manage the tax liability.

Ordinary income taxes from the distribution can be spread over a three-year period or can be paid in 2020 if income will be lower due to a furlough or layoff.  The CARES Act also gives individuals to three years to pay the money back into a retirement account so the distribution would not be taxable compared to just 60 days under the standard rules.

The available loan amounts, if available, have doubled to $100,000 or up to 100% of the vested balance in 401(k)s.

Should I rollover my 401(k) to an IRA?

For employees that have been let go, a decision must be made to leave money in a previous employer’s 401(k) or complete a rollover to an IRA. A 401(k) may provide the advantage of a loan option not given by an IRA but rolling to an IRA has several advantages.

An IRA allows investors to choose where they would like to invest their retirement account.  This means investors can choose a low-cost investment company which often have lower fees or a professional asset manager. An IRA will typically provide investors with greater fund options with lesser transactional paperwork. Each investor is different and should consult professionals to help make this decision.

Knowledge in power

In the face of fear and uncertainty, crucial decisions must be made based on facts and changing rules.  The CARES Act relaxes the rules to help Americans who qualify use retirement accounts through the pandemic. With more options, smart decisions based on investment and tax law will save money and ease the anxiety of many Americans without employment.