Everything you need to know about the new 401(k) no-penalty withdrawals in the CARES Act

April 2, 2020, 1:07 AM UTC

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It sounds awfully tempting.

As part of the CARES Act passed last week, some of the strictest rules about taking money out of your 401(k) are being temporarily lifted to help people affected by the coronavirus pandemic. But the changes drew some mixed reviews from financial planners. While the added flexibility may help some ride out the crisis, there was plenty of hand-wringing that the distribution limits were too high, and that people affected by coronavirus might be tempted to take out huge sums now—and, as a result, either put their eventual retirements in jeopardy or possibly leave themselves with a big tax bill.

Here’s a drill-down on what’s changed, and some guidance on how to approach your 401(k) in the wake of these changes.

What is a coronavirus-related 401(k) distribution? Is it really a no-penalty withdrawal?

One provision of the CARES Act relaxes the rules for taking money from your 401(k). The details? Investors of any age can take out a “coronavirus-related distribution” of as much as $100,000 (or up to 100% of the balance) without paying early withdrawal penalties. The act also increases the maximum “loan” from your 401k to this amount (previously that was limited to $50,000 or 50% of an employee’s balance).

Who is eligible for a 401(k) coronavirus-related distribution?

Unlike the stimulus checks, which will be orchestrated by the government, your company’s 401(k) plan sponsor will determine whether coronavirus-related distributions will be permitted, whether you meet the criteria for this type of distribution, and whether the amount you request fits the hardship you are facing. Generally speaking, anyone who has contracted the virus, has had a spouse or a dependent contract the virus, or has experienced financial hardship because of it, would be considered eligible. Plan sponsors that do permit such distributions can rely on an employee’s self-certification that they have been financially impacted by coronavirus.

Is a coronavirus-related 401(k) distribution a loan?

No. Unlike a 401(k) loan that must be repaid, a coronavirus-related distribution does not need to be repaid, according to Liz Masson, a partner at San Francisco-based law firm Hanson Bridgett. She explains that employees can repay the distribution within three years without regard to annual contribution limits for their 401(k) plans, and that the repayment does not need to be made all at once. Masson adds that any repayment of the distribution would be treated as a “rollover contribution” to the plan. But there’s a catch: an employee who takes a coronavirus-related distribution and does not pay it back will owe tax on the amount, through they will be able to pay the taxes owed over a three-year period says Masson.

Is it a good idea to take this new 401(k) distribution?

“It’s really a last resort,” advises Courtney Knoll, a clinical associate professor of accounting at the University of North Carolina, Chapel Hill and associate director of the UNC Tax Center. The problem? The whole idea of a 401(k) is that you are investing the money over a long-term period, so that the power of compound interest works in your favor throughout the duration of your career. And you’ll likely have to liquidate stocks to take money out, which means selling when the market is down nearly 30%.

Should I take my regular 401(k) distribution this year?

Another major provision under the CARES Act, says Knoll, is that minimum distributions (which refer to the required amount you must take out of your 401(k) upon reaching retirement age) have been waived this year. If you can afford it, “this is a great time not to be taking a distribution,” says Knoll. That’s because your minimum distribution number would have been calculated in 2019, when equity values were much higher. So if a bigger chunk comes out of your account now, the potential for your portfolio to rebound during the year is lessened. The bottom line, according to Knoll: “If you can avoid taking a distribution, you should.”

What if I take a 401(k) coronavirus-related distribution and then get laid off or furloughed?

As a huge number of companies are cutting back their workforces given the near-total economic shutdown, this is an important question. In normal times, if you take a loan from your 401(k) and then leave your company, many plans require that the money be paid back immediately, or else it is considered a taxable distribution. But under the CARES Act, according to Masson, “if an employee takes a coronavirus-related distribution and then leaves the company, the employee would not have to pay the distribution back.”

Can you still contribute if you are laid off, furloughed, or your hours are cut back? That depend on one factor: whether you’re still getting a paycheck. “Because employee contributions to a 401(k) plan are based on salary reduction elections, those contributions would stop when the employee is no longer being paid,” says Masson. She adds that if employees are being paid emergency sick leave or expanded family and medical leave under the Families First Coronavirus Response Act (FFCRA), those payments are eligible for salary reduction contributions to a 401(k) plan.

How is a 401(k) coronavirus-related distribution different from a hardship distribution?

Most plans allow for “hardship distributions” in, say, the case of a major medical event. But these differ from the current coronavirus-related distributions in several ways. Hardship distributions are taxed in the year taken, cannot be repaid to the plan, and are limited to the amount necessary to meet the financial need. One interesting note: Masson points out that in the state of California, COVID-19 has been declared a major disaster—meaning 401(k) plan participants there would be able to utilize a hardship distribution, and could elect a distribution in the “amount of expenses and losses (including loss of income) incurred on account of the disaster.”

Should I keep contributing to my 401(k)?

Experts are pretty much unanimous on this point: if you can keep up contributions—or even increase them—during this time, you should. “I’m not going to tell anyone how to time the market, but it’s clear that buying now is better than buying a month ago,” says Knoll. With the S&P 500 down 27% from its peak, any new money you are able to contribute (especially when paired with an employer match) will be put to work at far lower valuations now than were available for most of the past two years.

What are the 401(k) contribution limits for 2020?

At the end of last year, the IRS announced that for 2020, the maximum contribution for individuals in 2020 would be raised to $19,500. The so-called “catch-up” contribution for employees age 50 and over was raised to $6,500. The limits on annual contributions to an IRA remained unchanged at $6,000 per year.

Does my employer have to keep providing a 401(k) contribution match?

There’s nothing in the CARES Act that addresses this, and Masson notes that in general, employers can amend their 401(k) plans to stop making matching contributions, and that they should promptly notify employees of any changes.

More must-read personal finance coverage from Fortune:

When are stimulus checks coming? It could take months for some people
—Millions of Americans won’t be able to pay their bills this month. What financial experts advise
—Everything you need to know about the coronavirus stimulus checks
—5 things to know about unemployment benefits in the COVID-19 stimulus package
Everything you need to know about furloughs—and what they mean for workers
—How to defer your student loan payment due to coronavirus
What to do if you’re worried about getting laid off
—Listen to Leadership Next, a Fortune podcast examining the evolving role of CEO
—WATCH: U.S. tax deadline moved from April 15 to July 15

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