What Does the CARES Act Mean for Retirement Accounts?

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Christine Benz: Hi, I'm Christine Benz from Morningstar. The CARES Act included provisions that will make it easier for investors to get their hands on their retirement funds. Joining me to discuss what's changing and the pros and cons of 401(k) loans versus hardship withdrawals is Jeff Levine. He's the director of advisor education for Kitces.com, the director of advanced planning at Buckingham Wealth Partners, and the lead creator and content expert for Savvy IRA Planning. Jeff, thank you so much for being here.

Jeff Levine: Thank you so much for having me.

Christine Benz: Jeff, let's discuss the major implications of the CARES Act with respect to 401(k) loans. Let's start there. It seems like the big thing is that the limit is increasing.

Jeff Levine: Yeah, the limit increases actually in a couple of ways. So normally the absolute maximum that you can borrow from your 401(k) is equal to $50,000. And if you qualify under certain provisions--so either you or your spouse or a dependent have been diagnosed with the coronavirus, COVID-19, or you've been financially impacted in any number of ways, including furloughed, laid off, etc., or just a financial hardship as a result of quarantine--then you're eligible to increase that amount to $100,000 as a total maximum. Separately, plan loans are normally limited to a maximum of half your vested balance once you get to the $20,000 mark. So, once you get to $20,000, it's a $10,000 amount that you can borrow; if you get to $25,000, it's $12,500, so on and so forth. The CARES Act actually waives that requirement and says, "OK, once, you can actually borrow your entire vested balance." So for argument's sake, if all you had in your 401(k) today was $20,000, you could actually borrow that full amount from your plan all the way on up to that $100,000 max.

Christine Benz: So how will this work with respect to people proving that they've been economically affected by the virus in terms of their own healthcare? How will that process work?

Jeff Levine: One of the good things is that it's self-certification so you should be able to just call your plan and say, "Hey, I am entitled to this sort of relief," and self-certify that you've been impacted. A lot of what was done in the CARES Act revolves around self-certification or other issues whether it be this loan provision or frankly loans to businesses even. Because Congress realized that we've got to get money to people who need it desperately. We don't have time necessarily to do the normal background checks or fact checking that we would on other types of issues. So we've got to let people just say, "I am in this situation," and let them get the money that they need.

Christine Benz: Now let's talk about 401(k) and IRA hardship withdrawals because the CARES Act addressed those and made some changes there as well. What's going on with those accounts in the hardship withdrawals?

Jeff Levine: I think technically what you're referring to would be the coronavirus-related distribution provision correct?

Christine Benz: Right.

Jeff Levine: I would actually reframe that a little bit and not necessarily consider it a hardship withdrawal, simply because there are no hardship withdrawals from IRAs in general. And beyond that, the hardship withdrawals that you take from plans are just access to the money but there are really no special provisions to it. Here what's a little bit different is that the coronavirus-related distribution offers a whole variety of benefits for individuals who have been impacted. The first is that for those who are under 59 and a half at the time they take that distribution, it's going to be exempt from the 10% penalty. And by the way these are up to $100,000 amount also.

The second is that even for those who are not under 59 and a half, there are some benefits related to this coronavirus-related distribution. The first would be that the income from the distribution will generally be spread over three years, so 2020, 2021, and 2022 equally. Whereas normally when you take a distribution, it's all taxable in the year you receive it. Now I say that's a benefit, but it also could hurt some people. You should be very careful about whether you want to spread it out over the three years, or, if this applies to you, whether you would actually want to take it all and include it this year. You can elect to do that and include it all in 2020, and frankly if you're having a really bad year because you've been laid off or other reasons that your income is lower, this might be the year you want to include that in your income so that may be an option.

And then for those who are fortunate enough to recoup the funds and to be able to repay them back into a IRA, 401(k), or other type of plan, generally there's a 60-day window for being able to do that. The coronavirus-related distribution extends that until a three-year period following the date you received the distribution. So you could actually repay a distribution you receive today in 2022 and go back, amend your returns and get back the taxes that were otherwise paid on those distributions for those years. So lots of benefits in there for those individuals who qualify.

Christine Benz: The goal of these changes is to make it easier for people who are in a financial crunch to get their hands on some money, but I guess a question is, Should people pursue this avenue? Obviously ideally they would have some nonretirement funds that they would tap first, and then if they hit this fork in the road where they have some assets in 401(k)s or IRAs, how do they decide whether to do a loan versus doing one of these distributions to skirt the 10% penalty?

Jeff Levine: I think it really depends on what you think is going to be the route that you might go. Because if you take a loan, you're generally going to have to start paying that back. Now there is some additional benefit there in that loan payments that would otherwise be due from now through the end of the year are delayed one year. So there's a little bit of a grace period, but that would also require smaller payments to be required to begin to be paid back next year. Whereas with the coronavirus-related distribution, you have potentially three years and you could put it all back on the last day of the third year. Not that I would wait till the last day, but in other words you don't have to be making these smaller payments on the way.

So, it could be perhaps how much you think or how long you think you'll be going through these financial difficulties. You may not have a choice. Your plan may not have a loan and you may not have a plan. There is no loan provision from an IRA, so if you're talking about an IRA account and you need money, it's going to be the coronavirus-related distribution.

Christine Benz: Jeff, important topic I think a lot of people unfortunately will be in the situation of needing to find some cash, and we appreciate you walking through the pros and cons of these two options. Thanks for being here.

Jeff Levine: Thanks for having me.

Christine Benz: Thanks for watching. I'm Christine Benz from Morningstar.