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CARES ACT – Should you take your Coronavirus Related Distribution from your Retirement Plan?

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As you may have heard, the new “CARES” Act signed on March 27, 2020 creates a new “Coronavirus Related Distribution” option for participants in retirement plans who meet one of the following qualifications:

  • Are diagnosed with SARS-CoV-2 or COVID-19;
  • Have a spouse or dependent with one of these viruses;
  • Are laid off or furloughed, or have a reduction in work hours related to the virus;
  • Are unable to work due to a lack of child care due to the virus;
  • Have closed their business (or have reduced hours) due to the virus; or
  • “Other factors” the Secretary of the Treasury may determine.

Qualifying participants may withdraw up to $100,000 of their contributions and their employer’s contributions to their defined contribution (separate account type) retirement plan, with no early withdrawal penalty; however, the distributions must be by 12/31/2020.

While the Coronavirus Related Distributions will be taxable income, the participant may spread the income tax burden over three years, to help avoid pushing the participant into higher tax brackets.  Also, participants may repay the amounts withdrawn within a three year period.

This distribution option will go a long way to helping to relieve some of the financial hardships that are being experienced by participants across the country.  If you qualify should you take it?  Should you take less than all of the $100,000?  What are the negatives and other considerations?

  1. Loss of future income.  If you consider that your retirement plan is for your retirement then of course you want to maximize your account and allow the contributions to compound and grow to provide an adequate balance to support an active and healthy lifestyle in retirement.  From the standpoint of reducing your balance and losing the benefit of your future earnings on that amount the Coronavirus distribution is a bad idea, the same as any pre-retirement distribution.  The loss of $100,000 from your account today will cost you over $320,000 in your account in 20 years (at a 6% return) when you retire, which with a 4% withdrawal rate would be enough to generate an estimated $1,000 per month for the rest of your life!
  2. “Phantom income.”  If you take a Coronavirus distribution and spread the income taxes out over 3 years, you should have sufficient funds to pay the taxes in year 1, but will there be money to pay the taxes in years 2 and 3 when you have received (and possibly spent) the distribution in year 1?  You will have $33,000+ of taxable income in each of years 2 and 3, which can cost an estimated $8,000 to $10,000 per year in additional taxes.  Will you have the money at that time to pay the taxes (without creating a new burden for your family)?
  3. What about a loan from your retirement plan?  The CARES Act allows participants to borrow an increased amount from their retirement accounts.  In the past the loan limit has been $50,000, however, this amount has been increased to $100,000.  Plus, any payments due on an outstanding plan loan, which are due prior to 12/31/2020, may be delayed for one year.

Bottom line?  If you need the money take it, but take only the minimum, and most importantly pay it back if at all possible (even if you can only pay part of it back).  Consider your loan options first, a Coronavirus Related Distribution second. You’ll appreciate your sacrifices now in your retirement years.

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