You may have heard that the Coronavirus Aid, Relief, and Economic Security (CARES) Act allows “qualified” people to take certain “coronavirus-related distributions” from their retirement plans without paying tax. But what counts as a CARES Act 401k withdrawal?
The Basics of Early Distribution
In general, if you withdraw money from an IRA or eligible retirement plan before you reach age 59½, you must pay a 10% early withdrawal tax in addition to any tax on the income from the withdrawal.
There are several exceptions to this general rule. For example, you do not owe the additional 10% tax if you become totally and permanently disabled or if you use the money to pay qualified higher education costs or medical expenses.
The New Exception: Understanding CARES Act 401k Distribution
Under the CARES Act, you can take up to $100,000 in coronavirus-related distributions made from an eligible retirement plan in 2020. These CARES Act 401k distributions are not subject to the 10% additional tax that otherwise applies to distributions made before you turn 59½.
A CARES Act 401k withdrawal can be included in income in installments over three years, with a three-year repayment window. If you recontribute the distribution back into your IRA or plan within three years of the withdrawal date, you can treat the withdrawal, and later re-contribution, as a tax-free rollover.
Who is a qualified individual?
In new guidance (Notice 2020-50), the IRS explains who qualifies to take a CARES Act 401k withdrawal. A qualified individual is someone who:
- Is diagnosed (or whose spouse or dependent is diagnosed) with COVID-19 after taking a test approved by the Centers for Disease Control and Prevention (including a test authorized under the Federal Food, Drug, and Cosmetic Act); or
- Experiences adverse financial consequences as a result of certain events. To qualify under this test, the individual (or his or her spouse or member of his or her household sharing his or her principal residence) must:
- Be quarantined, furloughed, laid off, or have work hours reduced due to COVID-19;
- Be unable to work due to a lack of childcare related to COVID-19;
- Experience a business that he or she owns or operates close or have reduced hours due to the effects of COVID-19;
- Have pay or self-employment income reduced because of COVID-19; or
- Have a job offer rescinded or the start date for a job delayed due to COVID-19.
Under the new exception, many people, but not everyone, can take advantage of the option for CARES Act 401k distribution. If you decide to take advantage of the option to take a CARES Act 401k withdrawal, be sure to keep good records to show that you qualify.
Should you make a CARES Act 401k withdrawal?
Making a CARES Act 401k withdrawal will be ideal if you fit the above qualifications and think your need for funds will only be temporary since you will be taxed on the amount you do not recontribute within the three-year window. Even with tax, you will not have to worry about owing the 10% early withdrawal penalty if you are under 59½.
Other rules and restrictions apply to CARES Act 401k distribution. Maxwell Locke & Ritter is here to help with your 401k management, for the pandemic as well as your general needs. Contact us if you have questions or need assistance.