Withdrawing 401(k) Early During COVID-19: Risks & CARES Act Provisions

Read more on our COVID-19 Resource Guide.

Removing money from a 401(k) savings account before retirement often comes with significant payments and penalties attached. But the $2 trillion CARES Act coronavirus relief bill that the government has proposed aims to allow cash-strapped Americans to access their retirement savings to cover everyday expenses and bills without being penalized. It likewise promises to allow retirees the option to defer making minimum retirement distributions in a year when the market is down more than 20% from its February 2020 highs.

While it may sound tempting to tap into your retirement savings to cover loan payments and other common household costs, it’s best to defer doing so unless you immediately need money in-hand.

How To Withdraw Money Under The CARES Act

Traditionally, a 10% penalty on funds would be imposed if you sought to remove cash from your retirement account before age 59½, unless you’d suffered significant medical or economic hardship. Those over age 55 who’ve lost a job for any reason could also pull money from it without incurring financial drawbacks. But under the terms of the CARES (Coronavirus Aid, Relief, and Economic Security) Act, eligible parties can withdraw up to $100,000 from individual retirement accounts or 401(k)s sans penalty, so long as any money disbursed is paid back within 3 years.

To qualify for these benefits though, you’ll need to fall into one of two core categories. Either you or a member of your immediate family (e.g. a dependent – aka child – or spouse) must be formally diagnosed with COVID-19 (the coronavirus). In addition, those who have suffered sizable financial hardships due to being laid off, furloughed, quarantined, having their hours reduced, or being unable to work due to closures or child care shutdowns related to the epidemic qualify as well.

Plan participants who elect to remove funds can take the lesser of $100,000 or 100% of their vested balance in the plan out to help cover immediate financial needs. If you currently have an outstanding loan from your plan with repayment sums that are due between the date of the enactment of the CARES Act through December 31, 2020, you can also delay your loan payments by up to 1 year. While withdrawals may help you offset immediate short-term expenses, do be aware that unless the coronavirus has put a serious squeeze on your wallet, it’s best to think twice before seeking relief by tapping into your retirement funds.

Why It Pays Not To Remove Retirement Funds Early

Tempting as the prospect sounds, remember that removing funds from a retirement account while their value is depressed not only provides less return for every investment, but also inhibits growth potential when markets bounce back. While early penalties for withdrawing money are also temporarily waived, if you choose to take money out of your retirement account, you’ll also still owe income tax at some point on withdrawals. The more money that you’re able to keep in your retirement accounts, even during times of crisis, the longer this money will have to grow going forward and the harder it will work to help ensure your long-term success. Similarly, the more money that you remove from these accounts now, the likelier you are to receive lower payments in the future, including during your twilight years, when you’re likelier to experience financial shortfalls as well.

Given the opportunity, it’s best not to make the trade-off, and do a little belt-tightening now if possible, as opposed to potentially compromising your ability to enjoy a comfortable retirement. The worst time to take investments out of accounts is during a downturn, while investments are worth less, and can put a permanent dent in your portfolio. Consider that the process of compounding, which allows money to add up over time, is among your best vehicles for building wealth. Noting this, even smaller withdrawals that you elect to make can add up over time.

While it’s possible to spread out any immediate financial hits you might take for withdrawing funds early over a 3-year period in terms of income tax, there are potential long-term effects to your finances for doing so to consider. Likewise, it bears noting that retirement plan providers will still need to take steps to implement the CARES Act’s provisions, which may lead to some delays in terms of when you’re allowed to withdraw money as well.

Other Sources Of Funding Can Help You Make Up For Shortfalls

Do note that individuals who require immediate access to funds have other options that they can turn to for financial relief as well.

For example, if you’re an investor with taxable accounts, you might consider selling some investments (e.g. securities such as stocks) at a loss and using these losses to offset gains at a later date. You might also take out a loan of up to $50,000 out on your 401(k) if your plan allows it, helping you avoid income tax, though you typically need to still be working for the company which provides it, and these loans must be paid back within 5 years. In addition, emergency savings may prove a helpful fallback if you’ve been setting aside a nest egg to help ride out temporary market dips. Alternately, you could look into taking out a personal loan or home equity line of credit, with home values having recently been on the rise. Many individuals with more free time on their hands are further taking this downtime to reassess where they can cut back on monthly spending, or pick up side gigs to help offset any immediate drop in income.

If you’re a retiree, note that the CARES Act also provides you with options to skip taking required minimum distributions in 2020 in case financial markets are slow to recover and stock portfolios remain down, avoiding the need to calculate them off of inflated 2019 balances.

In any circumstance, though, it’s best to avoid withdrawing from your 401(k) under the CARES Act if at all possible. And if you do, it’s best to have a plan in place to help you save a little each week or month and replace these funds over time. That said, we live in extraordinary and eventful times. Sometimes, a little flexibility (and strategy) is required to make ends meet.