Interview: Utilizing the CARES Act for Easier Access to Retirement Funds
In March of this year, the CARES Act was passed with modified regulations for CRDs, or “coronavirus related distributions.” Essentially, this aid package allows loans up to $100,000 from a retirement account (IRA, 401(k) ) without the traditional taxes and penalties, even if you’re not the required 59½ years old just yet. But, lender beware, the law makes it absolutely clear that you must qualify for the specific CRD terms to avoid the traditional penalties before the age of 59 ½.
How Many People have accessed Retirement Funds through the Cares Act?
According to an article published on Planadvisor.com by Lee Barney on August 4, 2020, “Fidelity reported that, as of June 30, 2020, 711,000 individuals had taken a CARES Act distribution from their retirement account….T. Rowe Price only 4.2% of participants have taken a withdrawal, and fewer than 1% have taken out a COVID-19-related loan...Among Alight Solutions’ participants, there have been approximately 140,000 withdrawals, representing 4% of the eligible population. Interestingly, 51% of these people elected the maximum amount: either $100,000 or 100% of available funds.”
These terms can be confusing and costly if you don’t fully understand them and wish to access your retirement funds under them. To better understand these new regulations and important financial matters around retirement plan withdrawals, we ‘sat down’ with Brian Jessen, Managing Director at Forest Capital Management, LLC, a registered investment advisory firm headquartered in Chicago, Illinois.
Brian Jessen - Forest Capital Management, LLC
The CARES Act defines a participant eligible to receive a CRD or loans as a “qualified individual.” How has this been updated recently? Is there any mention of additional relaxed regulations in regards to upcoming federal aid packages?
Brian: Notice 2020-50 expands the definition of “qualified individual” to include an individual who experiences adverse financial consequences as a result of of COVID-19 such as:
- having a reduction in pay (or self-employment income);
- having a job offer rescinded or start date for a job delayed;
- being quarantined;
- being furloughed or laid off, or having work hours reduced;
- being unable to work for lack of childcare due to; or
- closing or reducing hours of a business owned or operated by the individual’s spouse or member of the individual’s household.
There are potential additional relaxed regulations in the upcoming federal aid packages. One item of note is the allowance of “self-certification” for increased 401(k) loans under the Democratic Bill named the HEROES Act. The Republicans have another bill entitled the HEALS Act and thus, there will need to be bi-partisan support for any new federal aid package to get pushed through to the President’s Desk.
Does updated eligibility expand beyond ‘spouses’?
Brian: Yes, a qualified individual under the CARES Act has had its definition expanded to include members of the individual's household. A member of the individual’s household is someone who shares the individual’s principal residence.
The CARES Act relieved IRA and 401(k) holders of required minimum distributions—can you expand on this?
Brian: Sure. RMDs are an annual amount of a retirement plan account (IRA or 401(k)) that retired holders of those accounts must begin taking as annual distributions and likely resulting in the taxable income of some sort. This gives those accounts more time to recover from the stock market downturns, and retirees who can afford to leave them alone get the tax break of not being taxed on mandatory withdrawals.
What are some precautions to be aware of in how to manage these new qualifications and regulations?
Brian: Depends on the perspective. For a plan sponsor: ensure your process is comprehensive and consistent. Yes, some employees may very well fit every definition of a qualified individual per the CARES Act, but it doesn’t mean you should sacrifice the process for speed.
What about individuals that had already taken out a 401(k) loan and lost their jobs due to COVID-19? How does this regulation, if at all affect those loans?
Brian: This depends on the plan requirements for terminated participants with outstanding loans. If the plan permits terminated participants to continue to make loan payments after their termination and the terminated employee is a “qualified individual” under the CARES Act, he/she would be able to request the suspension of their loan payments for up to 1 year.
What advice do you have for those who are considering taking a loan from retirement, what options are best to consider first?
Brian: A wonderful question without a truly universal response. Behavioral finance has shown us that many participants who take loans from their 401(k) accounts do so because “it’s my money” and “I’d rather borrow from myself.” A lot of this behavior should first be rooted in a “want” vs. “need” type analysis.
If you want to purchase something and you need 401(k) funds to afford it, it’s probably not a good idea to request a loan. If you have a “need” and don’t have savings bookmarked for such a purchase, borrowing from your 401(k) isn’t a terrible idea IF you only take what you absolutely need, and you don’t stop deferring into the plan. Too many participants take 401(k) loans and then stop contributing to their 401(k), setting them back years on the retirement savings and accumulation scale.
What documents or paperwork needs to be in order before tax season comes around again in 2021?
Brian: I believe (as of now) as it relates to CRDs, participants should receive a 1099-R. Participants who take CRDs will need to file a new Form 8915-E, which details the distribution and any re-contributions. This is a developing area, so this could change by the time the 2020 tax season rolls around.
Given this recent news, what are the best practices for the avoidance of the previously standard 20% tax and 10% penalty if one must take a withdrawal from these funds?
Brian: Qualified individuals who take CRDs are not subject to the 20% withholding they would normally be subject to if they took a distribution to their name. Further, CRDs are also not subject to the 10% early distribution penalty. Participants will potentially be subject to income tax, however, depending on the tax attributes of the dollars being requested out of a plan. However, the corresponding tax liability as a result of a CRD may be spread ratably over three years instead of paying tax on the entire taxable portion in the year of distribution.
Seek Further Guidance on CRD Withdrawals
If you’ve considered a 401K loan or withdrawal during the pandemic, further guidance is advised. Contact your employer on these new rules and ask specifics on what your own plan allows in regards to CRD withdrawals.
And finally, make it a first step to contact your financial planner and/or tax advisor for specific advice on your best options before making a withdrawal. Together with their advice and information from your employer on your plan specifics, a better decision on how much to withdraw, the option of a loan over a withdrawal, and the applicable taxes and fees can be discussed.
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