How the COVID-19 CARES Act Affects Your Retirement


Shannon B. says:

I read that due to COVID-19, the 10% penalty for withdrawing from retirement accounts will be waived. I’m wondering if this includes IRAs. And since I’m financially affected by the pandemic, would you recommend that I withdraw funds from my Roth IRA, which has $2,500, to pay bills?

Joyce asks:

Is the government letting retirees not take an RMD (required minimum distribution) in 2020 due to the stock debacle?

Jessica T. says:

I’m 26 years old and started a new job this January, but I don’t qualify for the 401(k) until I’ve been employed for a year. I was planning on starting a Roth IRA and possibly an investment account, but then the market became unstable due to COVID-19. When would be a good time to start investing in those accounts?

Thanks for your questions, Shannon, Joyce, and Jessica. It’s important to understand how new legislation relaxes retirement account rules—plus, the benefits of continuing to make contributions if you can.

Life has been changing quickly, and each week there seems to be a new policy response to deal with the spreading coronavirus. Congress has passed three bills to help Americans cope with the economic fallout of COVID-19:

  1. The Coronavirus Preparedness and Response Supplemental Appropriations Act became law on March 6 and authorized funding for activities including health care research and domestic and international response efforts.
     
  2. The Families First Coronavirus Response Act became law on March 18 and expanded benefits for workers, including paid sick and family leave, unemployment insurance, and protections for those in the health care workforce.
     
  3. The Coronavirus Aid, Relief, and Economic Security (CARES) Act, the largest stimulus legislation in American history since the New Deal in the 1930s, became law on March 27. It provides a variety of relief for individuals and businesses, including funds for various loans and grants, stimulus payments for taxpayers, suspension of payments and interest on federal student loans, and provisions that make it easier to access retirement funds.

That’s just the tip of the iceberg on what these laws provide. In this post, I’ll focus solely on ways the CARES Act affects your retirement account and answer the questions my listeners sent. You’ll learn how to manage your money better during this difficult time.

5 ways the CARES Act affects your retirement

Here are five updates you should know about how the CARES Act affects options and taxes related to retirement accounts.

1. Early withdrawal penalties are waived

Most retirement accounts impose a 10% early withdrawal penalty if you tap them for any reason before reaching the official retirement age of 59 1/2. Under the CARES Act, if you have a coronavirus-related hardship, this penalty is waived.

You can tap up to $100,000 of your retirement account balance during 2020 without having to pay an early withdrawal penalty.

For instance, if you, a spouse, or a child are diagnosed with COVID-19, or you have financial challenges due to being laid off, quarantined, having reduced work hours, or closing a business, you qualify for this exemption.

You can tap up to $100,000 of your retirement account balance during 2020 without having to pay an early withdrawal penalty. Income taxes would still be due in most cases. However, the CARES Act gives you a way to skip them, which I’ll review next.  

This no-penalty rule applies to workplace retirement plans such as a 401(k) or 403(b). And getting back to Shannon’s question, it also applies to IRAs such as a traditional IRA, Roth IRA, or a SEP-IRA (which is for the self-employed). But whether you should tap the account is another issue. We’ll cover that in a moment.

Remember that you make contributions to a Roth plan or IRA on an after-tax basis, so you can always tap your original contributions. That was the case even before the CARES Act. The earnings in the account would be subject to income tax if you withdraw that portion of your balance.

If you have an IRA or SEP-IRA, you’re in charge of making deposits and withdrawals. To tap it, contact your account administrator or use your online account to submit a withdrawal request.

If you’re employed with a retirement plan, your company’s human resource department or benefits administrator would determine if you meet the criteria and process your hardship request. They’ll primarily rely on you to certify that you’ve been financially harmed by the coronavirus and therefore qualify to have the early withdrawal penalty waived.

2. Tax on withdrawals is delayed

While you typically have to pay income tax on any retirement account withdrawal that wasn’t previously taxed, the good news is that you can delay or avoid tax altogether. Here are the options you have under the CARES Act for retirement withdrawals made in 2020:

  • Repay the hardship distribution within three years to your retirement account. You can replace the funds slowly (or all at once) with no change to your annual contribution limit, which is undoubtedly the best option. In other words, if you take money out but put it back within three years, it’s like you never took a distribution.
  • Pay taxes on the hardship distribution from your retirement account evenly over three years. If you can’t pay back your distribution, you can ease the tax burden by paying one-third of your liability for three years.  

Again, remember that tapping your original contributions in a Roth retirement account never triggers an income tax liability. So, if you have both a traditional and a Roth retirement account, you’re better off making early withdrawals from a Roth first.

3. Retirement plan loans are expanded

Some workplace retirement plans, such as 401(k)s and 403(b)s, permit you to take loans. Typically, you can borrow 50% of your vested account balance up to $50,000 and repay it with interest over five years.

For retirement plans that allow loans, the CARES Act doubles this limit to 100% of your vested balance in the plan up to $100,000.

For retirement plans that allow loans, the CARES Act doubles this limit to 100% of your vested balance in the plan up to $100,000. It applies to loans you take from your account within 180 days of the law, or until late September 2020, for coronavirus-related financial needs.

The repayment period for a retirement plan loan can be delayed for up to one year. For example, if you have $20,000 vested in your 401(k), you could take a $20,000 loan on June 1, 2020, and delay the repayment term until June 1, 2021. You’d have payments stretched over five years, ending on June 1, 2026. Any amount not repaid by the deadline would be subject to tax and a 10% early withdrawal penalty.

If you’re considering taking a loan from your workplace retirement plan, be clear about the interest rate and what would happen if you got laid off due to the coronavirus or any other reason. Also, try to keep contributing to your plan while you pay back a loan so you can continue getting any free matching funds offered by your employer and building your balance back up.

You can’t take a loan from an individual retirement account, such as a traditional IRA, a Roth IRA, or a SEP-IRA. They only allow you to take hardship distributions.

4. RMDs are waived

Another significant change under the CARES Act applies to required minimum distributions (RMDs) from certain retirement plans and IRAs. RMDs are annual withdrawals that you must begin taking from traditional retirement accounts after age 72, so you finally pay tax on balances that weren’t previously taxed.

Joyce asked about RMDs, and the answer is yes, you can skip it for 2020 if you wish. It may be a good idea if you can afford not to take a retirement account distribution this year and avoid the tax.

If you already took this year’s RMDs in January, it may not be reversible. However, if you took an RMD in February or March and want to reverse it, check with your account custodian to see what’s possible.

5. You have more time for IRA contributions

The CARES Act postpones the 2019 tax filing deadline from April 15, 2020, to July 15, 2020. That means you also have until July 15 to make IRA contributions for 2019.

Many people have asked me if it’s still worthwhile to put money into their retirement accounts. Jessica asked whether she should start a Roth IRA amid so much volatility in the financial markets. The answer is absolutely, positively, yes!

If you can keep up your contributions to a workplace retirement plan, an IRA, or a retirement account for the self-employed, or even increase them right now, you should.

If you can keep up your contributions to a workplace retirement plan, an IRA, or a retirement account for the self-employed, or even increase them right now, you should. Purchasing funds at lower prices means you’ll make money when the price eventually goes back up. When the market is down, your retirement contributions have the potential for higher-than-normal growth.

Max out one or more retirement accounts when you can. For 2020, the contribution limit for a workplace plan is $19,500, or $26,000 if you’re over age 50. For an IRA, you can max out at $6,000, or $7,000 if you’re over 50.

If Jessica maxes out a Roth IRA and has more to invest, she could put her money in a regular brokerage account. A wise strategy is to choose one or more diversified funds and make regular contributions over time, which is known as dollar-cost averaging.

For instance, contributing $500 per month for a year would allow you to max out an IRA. When investment fund prices are low, your $500 buys more shares, and it buys fewer shares when prices go up. Over time, your investment return is smoothed out and determined by the overall trend in the market.

Remember that the point is to invest money for the long-term and create security for the future.

Since Jessica is just 26 years old, she has plenty of time to build a significant nest egg. I’d recommend that the majority of her investments be in stock funds or in a target-date fund that allocates automatically over time. Stocks and stock funds are the riskiest types of investments, but they give you the highest potential returns.

The ideal investment allocation is to be reasonably aggressively when you’re young and to become more conservative as you get closer to retirement. That’s true whether you invest through a tax-advantaged retirement account or using a taxable, regular brokerage account.

While the CARES Act gives you much more flexibility to tap a retirement account, remember that the point is to invest money for the long-term and create security for the future. I recommend only dipping into one as a last resort.



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