The 2020 CARES Act, Hardship, and Retirement Accounts: What You Need to Know

For retirees and those saving for retirement, 2020 will go down as one of the strangest years in their lives. The movements in both the stock and bond markets have created crater impacts in many retirement accounts. It has also put a great strain on income and even job security.

But for those struggling to deal with the economic impacts of this pandemic, there might be some hope.

The Coronavirus Aid, Relief, and Economic Security, or CARES Act, includes a few temporary tweaks to the way both loans and distributions from retirement accounts work. While the situations individuals are navigating may still be complex and scary, this Act brings changed that are intended to help.

Part of what this Act includes is measures that allow people to lean on their retirement accounts to get through this dark period.

Early Withdrawals Due to Hardship

For 401(k)s and IRAs alike, there have always been rules regarding withdrawing money due to financial hardship. Medical emergencies, divorces, and even purchasing a home have excused the 10% early withdrawal penalty in times past, although the exact eligible circumstances vary according to the individual plan. Some plans are more lenient in regard to early withdrawals.

The CARES Act attempts to codify some of the language regarding early withdrawals in direct relation to the economic disaster resulting from the COVID-19 pandemic. Here’s what the new law does:

• Penalty-Free Early Withdrawals – For qualified retirement accounts of all types (including IRAs and 401(k)s) and qualified individuals, the IRS is waiving the 10% early withdrawal penalty for all distributions less than $100,000 taken during 2020.
• Extends Tax Consequences Over a 3-Year Period – While you still owe taxes on those distributions, you can spread them over a three-year period that starts in the 2020 tax year instead of having to pay them at once.
• Extends Recontribution of Early Withdrawals – Normally, you have 60 days to avoid both taxes and penalties to recontribute or roll over those funds into a qualified account. That’s been extended to three years.*
• Extension of 60-Day Rule – For all unwanted RMDs taken between February 1 and May 15, 2020, the IRS is allowing a rollover back into their IRA or plan (although the rule that says this can only happen once-per-year is still in effect) through July 15, 2020. This eliminates the tax bill on that RMD.
• Adds Specific Language Regarding Hardship Withdrawals – To qualify for the above extensions and waivers, the account holder must meet one of the following criteria:
  • Diagnosed with COVID-19, with a CDC-approved test
  • Have a spouse or dependent diagnosed with COVID-19
  • Experience a financial hardship directly related to the coronavirus, such as loss of job due to quarantine, forced business closing, reduction of work hours, or inability to find work.
  • Cannot work because of lack of child care as a result of the coronavirus.

*NOTE: While penalties are waived, taxes are still owed if you take advantage of this extension. If you do wait until after the end of 2020 to repay any portion of what was withdrawn, you will owe taxes on that amount. But you can spread that tax bill over the next three years.

While on the subject of distributions, the CARES Act does waive another core requirement of retirement accounts. If you’ve turned 70½ or 72 (depending on the account in question) and would otherwise be required to take a mandatory distribution this year, you are exempt for 2020. All required minimum distributions, or RMDs, are on hold for this one single year—saving you from heavy taxes on your RMDs.

Of course, early withdrawals and RMD waivers are only a part of this new bill. For 401(k) owners, there’s another element to it.

401(k) Loans in 2020

While you cannot take out loans from an IRA, you can through most 401(k) and 403(b) plans. And if you find yourself in a situation where you might need to consider an early withdrawal, think carefully about a loan as well.

The largest difference between early withdrawals and loans lies in the tax implications behind each. While the early withdrawal penalty has been removed for hardship distributions, the IRS will still take its taxes, even if they are spread over three years. For loans, there are no taxes—at least for now.

Under the CARES Act, a loan taken from a 401(k) right now won’t owe taxes on the amount borrowed if it is repaid within the next five years. That’s a longer grace period and more enviable tax consequence that’s worth considering, if you have the option.

There are a few things to note about these loans, however.

• This new CARES stipulation is only partly retroactive. If you already have an outstanding 401(k) loan, you can delay payments this year only. The taxes you owe will still be the same, meaning that you don’t have the same five-year window as someone taking out a new loan right now.
• For other new loans that do qualify, they must be made within 180 days of the signing of this law. This gives you about six months to qualify for such a loan.
• There is a cap on qualifying loan size. While the Act doubles the eligible amount from $50,000 to $100,000, it’s important to note that this amount is the maximum total amount of loan(s) that may be given from your retirement. So, if you have multiple 401(k) loans, they can only add up to a grand total of $100,000 or less.

Other Important Retirement Account CARE Act Provisions

With so many direct changes to how distributions, withdrawals, and loans work throughout 2020 and even in the years to come, there are a few other stipulations or rules you should be aware of:

• “Rule of 55” – Even without this new law, the IRS has a rule for individuals who leave their employer for any reason after the age of 55. Now, most accounts only drop the 10% early withdrawal penalty after the age of 59½. But if you leave your employer where you had a 401(k) between the age of 55 and 59½, you are also exempt from that penalty. Even if you don’t qualify for the CARES Act hardship waiver, you might still be exempt from the penalty.
• Number of Loans From a 401(k) Vary From Plan to Plan – Even if you have room for additional loans under the net total $100,000 401(k) loan limit, you need to check with your plan to see if you are allowed multiple loans. Many plans only allow one loan at a time. Some plans might relax this rule, particularly given the pandemic and economic hardship many are facing. It’s worth checking for a loan first before opting for an early withdrawal.
• Waivers and Extensions Apply to More Than You Might Think – As noted above, those who qualify for these new rules include any worker who can claim any hardship due to COVID-19. While they would directly apply to you if you had any change in your employment (fewer hours, closed stores, etc.), they would indirectly apply to you if the same happened to your spouse. Additionally, if you have children kept out of school or child care, these rules would also trigger. Check with your plan administrator to see if you qualify as well as to determine what sort of documentation is required.

Of course, no one wants to rely on their hard-earned retirement savings to deal with any financial crunch. And if you can avoid it, even with these slackened rules, it may be wise to do so. But knowing what you qualify for and how to navigate these changes can be the difference between a massive tax bill or a missed opportunity, and can also help alleviate any financial anxiety you are currently facing.