As part of the CARES Act, which was passed in 2020, there is a provision temporarily amending the rules for taking early distributions from retirement savings plans, including 401(k) plans and individual retirement accounts (IRAs). Essentially, if you needed cash, you could take up to $100,000 from your retirement plan, even if you are under the normal minimum age of 59.5, without being assessed the 10% penalty charged on early withdrawals. These withdrawals are still treated as normal income, though, so you’ll have to pay regular taxes on it. That is, unless you own a Roth account. This income can be spread over up to three years so your income isn’t too high in a single year. If you need help figuring out how to manage your withdrawals, consider working with a financial advisor.
When there isn’t a global pandemic impacting the livelihoods of the entire nation, withdrawing money early from a retirement plan is a serious decision. That’s because it carries with it some pretty serious consequences: namely, a 10% penalty paid on all of the money you withdraw, in addition to paying normal taxes. This, of course, assumes it is not a Roth plan, where the money has already been taxed.
Even if you’re willing to pay the penalty, you have get approval from your plan beforehand. This is typically known as a hardship withdrawal. Some plan sponsors may not be willing to grant them, so make sure you check with your HR department before you plan on making one. Acceptable reasons for a hardship withdrawal include:
Note that these reasons still carry the 10% penalties, in addition to taxes. There are a few instances where the penalty is waived:
The CARES Act had many provisions that received attention, especially the Paycheck Protection Plan (PPP) loans and the individual relief checks that went to a majority of Americans. One less-noticed part of the bill, though, changes the way that pre-retirement withdrawals from retirement plans work.
Section 2022 of the CARES Act allows people to take up to $100,000 out of a retirement plan without incurring the 10% penalty. This includes both workplace plans, like a 401(k) or 403(b), and individual plans, like an IRA. This provision is contingent on the withdrawal being for COVID-related issues. The following reasons are permitted for making these special withdrawals:
This is obviously a fairly broad set of circumstances. Essentially, if you’re having a hard time financially because of circumstances caused by the pandemic, you’re likely to qualify for these early withdrawals.
The same rules apply to IRAs, though you’ll instead go to the plan administrator rather than your company. But you can still make a withdrawal of up to $100,000 for COVID-related reasons. Note that these withdrawals had to be made before Dec. 30, 2020.
Though you don’t have to pay the 10% penalty on these withdrawals, you’ll still owe taxes on the money you withdraw. To make things a bit easier, though, the CARES Act allows you to spread the income over three different tax years.
For example, if you borrowed $30,000, you can apply $10,000 to your 2020 taxable income, $10,000 in 2021 and the last $10,000 in 2022. You must take at least one-third of the money in each year, though. You can also opt to take more in any year, including up to all of the money if you so choose.
If, in a later year, you’ve made back the money you withdrew, that is allowed. You’ll have to file an amended return for any years with withdrawal money to get a refund. Again, the same rules apply for IRAs and 401(k)s.
The COVID-19 pandemic impacted all elements of Americans’ lives. It changed the way we work, shop and spend time with our friends and families. It also brought major changes for many people financially, including their retirement savings and taxes.
Normally, any withdrawals from a 401(k), IRA or another retirement plan have to be approved by the plan sponsor, and they carry a hefty 10% penalty. Any COVID-related withdrawals made in 2020, though, are penalty-free. You will have to pay taxes on those funds, though the income can be spread over three tax years.
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Ben Geier, CEPF®Ben Geier is an experienced financial writer currently serving as a retirement and investing expert at SmartAsset. His work has appeared on Fortune, Mic.com and CNNMoney. Ben is a graduate of Northwestern University and a part-time student at the City University of New York Graduate Center. He is a Certified Educator in Personal Finance® (CEPF®) and a member of the Society for Advancing Business Editing and Writing. When he isn’t helping people understand their finances, Ben likes watching hockey, listening to music and experimenting in the kitchen. Originally from Alexandria, VA, he now lives in Brooklyn with his wife.
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