The CARES Act Allows for Early 401(k) Withdrawals. But Is It a Good Idea?

April 9th, 2020

 
If you’ve been impacted financially by the coronavirus, the $2 trillion economic relief/stimulus plan (CARES Act) may offer some assistance. In fact, one part of the act allows you to access your 401(k) or IRA funds early without paying a penalty.
 
So is it something you should do?
 

First off, not everyone qualifies

The rule specifies that this only applies to people who have been directly impacted by coronavirus, which includes any of the following;
 
• You, your spouse, or dependent have been diagnosed with the coronavirus (COVID-19)
 
• Your finances have been negatively impacted because you have been quarantined, laid off, furloughed, or have had your work hours reduced
 
• You’re unable to work because of a lack of child care due to coronavirus
 
• You own or operate a business and have had to close/reduce hours due to coronavirus
 

If you do qualify, what are the specifics?

Keep in mind, there are some rules around how this works.
 
The maximum you can take out is $100,000

Normally you would be charged a 10% penalty for taking money out of your 401(k) or traditional IRA before the age of 59 and a half. But this rule allows you to take out up to $100,000 without incurring the penalty.
 
You WILL owe income taxes, but you have three years to pay them

Although you won’t be hit with the 10% penalty, you will have to pay taxes on the money (since your contributions were originally tax-deductible). But you can spread the taxes out over three years. And if you recontribute the money back to your account within three years, you won’t owe any taxes. (Note: if you take money from a Roth IRA or Roth 401(k), you won’t owe taxes since you’ve already paid income taxes on that money).
 
You can recontribute the funds to your retirement account

If you recontribute the funds to your retirement account within the next three years, it won’t count towards your annual contribution limits.
 

So should you take money out?

Short answer – ideally, no. This should really be viewed as a last resort since it’s best to let these funds grow until retirement time. You’d want to tap into your emergency fund first. That’s why you have it.
 
Also keep in mind, taking money out means you’ll have to sell investments, which have probably gone down a lot in the past few weeks. The S&P 500, Dow, and Nasdaq are all down about 20% as of the writing of this. Ideally you want to keep this money invested for the long term and weather the inevitable bumps.
 
There are other parts of the CARES Act that might help you out financially too. The act is increasing unemployment insurance (extending the time, the amount, and definition of eligible individuals) and will be issuing $1,200 stimulus payments to most adults. It’s also setting aside $350 billion for small business loans with favorable terms.
 
So to summarize, if you’re really stuck and have absolutely no alternatives, except for high-interest options like payday lenders or personal loans, then taking money from your 401(k) could be the right move. Otherwise, you’ll probably want to avoid touching it.
 

Anything else we can help you with?

► Why it might be a good time to refinance your student loans

► Understand if stocks are “cheap” now

► Read about the new IRS tax deadline and how to file
 

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