One of the less-publicized measures Congress included in the CARES Act was a mechanism for business owners and individuals to utilize funds saved in their retirement accounts to help alleviate the financial hardships of the pandemic.
Of course, anytime you’re considering tapping into a retirement account for immediate cash needs, it’s critical to evaluate the rules and regulations to decide whether this is the best course of action for you and your business.
Among the downsides to utilizing retirement funds for this purpose is the loss of potential investment gains in the account and the tax burden from withdrawing funds before reaching age 59 and a half.
If you plan on utilizing your 401K funds, borrowing from the account rather than taking an early cash withdrawal will avoid the immediate tax penalties — however it’s critical to pay back the loan in the specified timeframe.
Section 2202 of the CARES Act makes the process easier, but you must meet specific requirements to take advantage:
Who Qualifies for the New Rules
The CARES Act’s special distribution rules are available only to taxpayers who were adversely affected by the pandemic in at least one of the following ways. To qualify, a retirement account holder must certify that he or she:
- Was diagnosed with COVID-19 or has a spouse or dependent diagnosed
- Suffered adverse financial consequences from being quarantined, furloughed, laid off, or having work hours reduced
- Is unable to obtain work because of a lack of childcare due to the virus
- Was forced to close or reduce hours of a business he or she owns or operates
IRS Notice 2020-50 later expanded this list to include self-employed workers, as well as taxpayers who had other household members suffer any of the adverse financial consequences listed in the Act.
CARES Act Changes
For those who meet one of these qualifications, the CARES Act waives the 10 percent penalty that is normally imposed on early distributions from retirement plans. The distributions must still be reported as income, but qualifying taxpayers may report the income ratably over a three-year period instead of entirely in the year the distribution was received. Furthermore, if they repay their distributions within three years, they may treat them as tax-free transfers and request refunds of the relevant taxes. These distributions must be taken before December 31, 2020 and are limited to $100,000 per taxpayer.
The CARES Act also relaxes the rules regarding loans from employer-sponsored plans. For coronavirus-related loans, it extends all payment due dates between March 27 and December 31, 2020 by one year and adjusts subsequent due dates accordingly. This effectively gives qualifying taxpayers six years to repay a new loan instead of the normal five. An earlier rule change already gave taxpayers additional time to repay loans if their employment is terminated.
The Act also temporarily increased the maximum amount that could be borrowed from a qualified plan, but that provision expired in September. The maximum loan amount has now reverted to $50,000 or 50 percent of the vested account balance.
The Employer’s Role
It’s possible that your specific 401(k) plan does not allow loans or has not amended its rules in line with the CARES Act changes — but you can still take advantage of the tax benefits.
Under normal circumstances, a plan administrator would be charged with reviewing bills and receipts to determine how much of a loan an employee make take from their retirement plan. However, under the CARES Act, an employee can certify their eligibility on their own, lessening the administrative burden on the employer.
Certainly, the CARES Act has made it easier to utilize your retirement funds to meet your immediate expenses, but it’s important to make an informed, thoughtful decision.
Get in touch with Dembo Jones experts for a full analysis of your cash flow concerns and insight into whether your business should take advantage of the Cares Act rules regarding retirement plan withdrawals.