Thanks to the CARES Act, it’s easier than ever for your employees to pull money out of their 401(k). You’ll likely be fielding a lot of phone calls with plan participants wondering if they can access this cash to get by during the global pandemic. Whether or not employees have access to their retirement accounts early is up to you.
CARES Act Lifts Restrictions on 401(k) Loans
The CARES Act offers relief by loosening restrictions on 401(k) loans and distributions by:
- Penalty-free distributions allowed – Qualified participants (diagnosed with COVID-19, caring for a spouse or dependent with COVID-19, or otherwise laid off/furloughed/unable to work) can take out up to $100,000 without paying the 10% excise tax for early withdrawal. The distribution is not taxed if repaid within three years.
- Bigger plan loans allowed – In the past, plan participants could take out up to 50% of their account balances (up to $50,000). Now, qualified participants can take out 100% of their balances (up to $100,000). There is no 10% “early withdrawal” penalty for participants who are under 59.5 years of age. Loan repayment can be suspended until December 31, 2020. Interest continues to accrue, but participants can take up to five years to pay off their loans.
- No required minimum distributions – RMDs for those age 72 or over can be waived for the remainder of 2020 to avoid selling at undervalued prices.
- New parents can take money out – Americans who just had a baby or adopted a child can take up to $5,000 from a 401(k) or IRA without the typical 10% penalty. Feasibly, if they have separate retirement accounts, a couple could take up to $10,000 in total. New parents may opt to repay, but the borrowed cash does not have strict repayment protocols in place.
Note that all of these provisions have been approved by the IRS, but are optional for employers to incorporate into their plans. Some plan recordkeepers have started proactively implementing the changes, allowing employers a brief opt-out period. Now is a good time to discuss the CARES Act provisions with your plan provider if you haven’t already.
Not All Employees Can Take 401(k) Withdrawals
The IRS generally mandates that employees leave their money in a 401(k) account until reaching age 59.5, become permanently disabled, suffer a specific financial hardship, the plan dissolves, or the worker leaves the company. People who have met these conditions can take funds out of the 401(k), though the approved amount may vary.
In some cases, employees can be refused if:
- The employee has not saved enough to take out yet. While rules allow employees to take up to $100,000 in a loan, most young Americans have far less than that in their accounts. The average American age 56 to 61 has $21,000 in a 401(k) account. Millennials from 32 to 37 have an average of $1,000 accessible in their 401(k)s.
- The plan requires employees to first become “vested” after a certain number of years before they can access the funds put into the account.
- The employee is under 59.5 years of age. A 10% early withdrawal penalty may apply.
- The employee does not meet hardship requirements. The IRS allows money to be taken out of a 401(k) to cover medical expenses, funeral bills, college tuition, health insurance premiums, down-payments on a starter home, to avoid eviction or foreclosure, to pay court-ordered alimony or child support, or to cover expenses related to “a federal disaster.”
Borrowing from a 401(k) Should Be a Last Resort
Economists recommend tapping a 401(k) as a last resort. Why?
- A 10% penalty applies if the money is withdrawn early for any reason aside from an approved hardship.
- Consumers have to pull out a larger percentage of assets, as they are worth less during a downturn.
- There will be no compounding during the withdrawal period (which is typically about 7% per year.)
- The amounts saved during the first 10 years of investing can account for 50% of the balance by age 65.
- Income taxes will still be owed on withdrawals from traditional 401(k) deferrals and employer matching.
The ideal scenario would be to tap emergency cash savings. Americans are advised to keep at least three to six months of expenses in a cash savings account for emergencies. Homeowners may consider taking a low-interest line of credit. Personal loans from a local credit union can help consolidate debt or make a big purchase, though the interest rate can be 10% or higher.
We’ve only just skimmed the surface of the questions you may face here. Call us for more personalized financial advice about starting, changing, or updating your 401(k) plan. Ubiquity specializes in working with small businesses.
