COVID-19: Should You Take $100,000 From Your 401(k) or IRA?

The Coronavirus Aid, Relief, and Economic Security Act (CARES) Act was signed into law on March 27, 2020, by President Donald Trump. Amidst the global COVID-19 pandemic, the CARES Act is designed to provide economic relief to individuals and businesses who have been affected by the resulting economic downturn.

Section 2202 of the act, titled “Special Rules For Use of Retirement Funds,” now allows individuals impacted by COVID-19 to withdraw up to $100,000 penalty-free from their 401(k) or IRA.¹ 

What does it mean to be "impacted by COVID-19?" The broad definition given by Congress includes those who:

• Have been diagnosed with COVID-19;
• Have a spouse or dependent who has been diagnosed with COVID-19;
• Experience adverse financial consequences as a result of being quarantined, furloughed, being laid off, or having work hours reduced because of the disease;
• Are unable to work because they lack childcare as a result of the disease;
• Own a business that has closed or operate under reduced hours because of the disease; or
• Meet some other reason that the IRS decides to say it is OK.

The biggest question regarding this new option to withdraw from your 401(k) or IRA is, should you consider taking it? Below, we will discuss what you need to know and consider before making the decision.

Penalty-Free Access to Retirement Savings

Traditionally, there has been a 10 percent penalty for withdrawing funds from a 401(k) or IRA account before reaching the age of 59 ½. But through changes passed in the CARES Act, this penalty will be waived for individuals who choose to tap into their retirement savings accounts and withdraw up to $100,000 to cover financial burdens caused by the COVID-19 pandemic.¹

If you choose to withdraw, you will have the option to spread the tax liability of this additional income over the next three years, and you will have three years to return savings (up to the full amount withdrawn) back into the account.¹

Increase in 401(k) Loan Limits

Aside from withdrawing altogether from your retirement savings account, some plan sponsors offer the option of taking out a loan on your 401(k) or IRA. In the past, there have been limits on how much you can withdraw. According to the IRS, the maximum amount was previously “(1) the greater of $10,000 or 50% of your vested account balance, or (2) $50,000, whichever is less.”² 

In light of recent events, the CARES Act has adjusted this loan limit to a maximum amount of 100 percent of your vested account balance, or $100,000, whichever is less.¹ This option will be available for individuals for 180 days after the CARES Act is enacted. Additionally, anyone owing a 401(k) loan repayment before December 31, 2020, can delay their repayment for up to one year.¹

While the amount you can withdraw in a loan has doubled, it is important to remember the IRS has not changed its rules on loan repayment. Your repayment must occur, “within 5 years, and payments must be made in substantially equal payments that include principal and interest and that are paid at least quarterly,” according to the IRS.² Which means you should be fully prepared to pack back the entirety of the amount borrowed in substantial installments each year if you take this option.

Considerations About Withdrawing From Your Retirement Savings

As is true for any other circumstance, the decision to withdraw from your retirement savings account early should never be taken lightly. Depending on your timeline toward retirement, $100,000 accruing compounding interest over the next couple of years could yield significant growth. In fact, the younger you are, the greater the dent you’re putting on your future retirement funds - if you choose to withdraw from your 401(k) or IRA without paying it back.

As you address the need for money now, remember to consider your need for money in the future. Is creating a significant reduction in your future retirement income the best option for addressing your present financial hardships, or would it be better to pursue alternative options - such as a personal loan, HELOC or tapping into your emergency savings?

Before making a big financial decision like this, it’s important to work together with your financial advisor. He or she can help you understand the long-term impact a decision like this can make on your financial future.