The CARES Act, the legislation just signed into law by President Donald Trump, contains plenty of provisions for those saving for and living in retirement. But experts say those who can take advantage of the new law have lots to consider.
The law temporarily loosens the rules on hardship distributions from retirement accounts, giving people affected by the crisis access of up to $100,000 of their retirement savings without the usual 10% penalty.
The law also doubles the amount 401(k) participants can take in loans from an account for the next six months to the lower of $100,000 or 100% of the account balance. IRAs don’t permit loans.
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The new rules apply to a whole range of people, including those who have lost a job because of the pandemic, those suffering from COVID-19 or who have a spouse with the virus.
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If your emergency savings fund is running low, it may make sense for you to use your 401(k) to ride out the COVID-19 pandemic, says Keith Whitcomb, the director of analytics at Perspective Partners. “The CARES Act is designed to enhance this financial alternative,” he says.
Is the money worth the disruption?
While the new law provides more options for people who are struggling financially, think carefully before acting.
Having to sell investments at a much lower price in the COVID-19-induced stock market sell-off can knock your 401(k) out as a potential source of funds, says Whitcomb. “This is true regardless of whether you borrow or take a hardship withdrawal from your account,” he says. “However, if your 401(k) has assets in cash or short-term bonds that have not been affected by the market decline, it may make sense to sell those investments in order to generate cash.”
Also, disrupting the accumulation of 401(k) assets with loans and hardship withdrawals is generally discouraged. “However, if a 401(k) withdrawal enables you to lower your current payments, refinance at a lower interest rate, or eliminate debt, the net result can strengthen your financial circumstances while simultaneously helping you pay your bills,” says Whitcomb.
Whitcomb also notes that the COVID-19 crisis has destabilized the job market as businesses close to stop the spread of the potentially deadly virus. “This can factor into your decision because if you leave or lose your job when you have a 401(k) loan, it must be paid in full by that year’s tax return deadline,” he says. “With some exceptions, you would normally pay income tax and a 10% penalty on any outstanding balance. However, the CARES Act eliminates the penalty, making the amount subject only to income tax.”
Remember, says Whitcomb, even with the help of the CARES Act, hardship withdrawals from your 401(k) will still be considered as ordinary income for tax purposes. “But if you are backfilling lost wages from a layoff, your tax bill may end up being about the same as a ‘normal’ year,” he says.
Others also note that waiving the 10% early withdrawal penalty will be helpful to many retirement account owners. “It’s welcome to people who have no other resources but to touch retirement to provide the temporary financial relief,” says Rose Swanger, a certified financial planner with Advice Finance. “As old sayings goes, bills do not stop coming just because one is sick or out of job.”
Here’s one tactic to consider if you intend to take a distribution. Sell the fixed income portion of your portfolio. That way you leave your stocks “intact to participate in the recovery when it happens,” says Charles Sachs, a certified financial planner with Kaufman Rossin Wealth.