With so many people out of work and struggling to keep up with their bills during the coronavirus pandemic, the opportunity to dip into retirement savings without incurring any extra upfront costs could be a valuable lifeline.
In response to the sudden economic downturn, Congress took steps in late March to make it easier for Americans to withdraw money from their retirement accounts if they were affected by the pandemic. Under the $2 trillion stimulus package, Americans can take a withdrawal of up to $100,000 from their retirement savings, including 401(k)s or individual retirement accounts, without the typical penalty. Referred to as "coronavirus related distributions," they are available only in 2020.
Unfortunately, this fix is not an option that's available to everyone.
Before the pandemic gripped the country, Dee* worked two jobs, both at hospitals near Billings, Montana. But like roughly 30 million other Americans, she's been out of work going on nearly two months, a situation that's put a lot of strain on her household's finances. Because of her age and ongoing health conditions, Dee, 62, had to quit one job where she was required to interact directly with Covid-19 patients. Her other job was furloughed until non-coronavirus patients start returning to hospitals.
She did file unemployment but says she has yet to see any money from that. "You can't get through on the phone, and they aren't answering e-mails," Dee says.
With bills mounting and unemployment stalled, Dee and her husband (who is still working) thought they found a solution to their problem thanks to the new withdrawal rules: They would dip into her husband's retirement savings.
Despite new rules, this relief may not be an option
Before the March legislation passed, if you needed to access retirement funds before age 59½, you generally had to pay a 10% penalty on any amount you withdrew, as well as income taxes. There were a few exceptions to that rule, including education expenses, buying your first home, covering massive medical debts or being ordered by a court to provide alimony or child support.
If you were over age 55 and lost your job, whether you were laid off, fired or quit, you could also pull money out of your 401(k) or 403(b) plan without penalty.
"My husband is still working, but the loss of my income from two jobs for nearly two months has been significant," Dee says. So the penalty-free withdrawal felt like one of the few available options that wouldn't cost them a lot of money upfront. The March legislation gives Americans three years to either pay the taxes due on the withdrawal or to pay back the money and not owe taxes on it.
Unfortunately, getting a coronavirus related distribution, or CRD, isn't available to everyone. While Congress made it easier to take a withdrawal without incurring any penalties, it's not guaranteed. Retirement plan providers read the new law's withdrawal exemption as an optional plan feature, which means that the decision whether to offer this benefit rests with the employer.
This is a so-called "plan event" and is something that needs to be signed off on by the company, says Michael Hadley, a lawyer with the D.C.-based law firm Davis & Harman
In Dee's case, her husband's employer voted not to adopt the coronavirus related distribution — a fact the couple learned after the withdrawal request had been denied. "They felt that since their employees were still working, they didn't see the need — forgetting, possibly, that many are dependent on income from a spouse who did get laid off because of the unexpected Covid-19 shutdown," Dee says.
Yet this situation is far from unique, Hadley says. "There are a lot of employers that have decided not to implement CRDs." Almost half, 44%, of plan sponsors were still deciding which of the CARES Act provisions to implement, according to a survey by the Plan Sponsor Council of America released April 14. Of employers that have made a decision, almost 70% of large organizations are allowing CRDs up to $100,000 or 100% of the vested amount, as opposed to only about one in five smaller organizations.
Hardship withdrawal may also be barred
Despite the fact that many plan sponsors aren't allowing CRDs, there are still other ways Americans can access their retirement savings early. Dee persisted, requesting instead a disaster hardship withdrawal. Typically, these types of withdrawals are available if you have suffered a loss of income because you live in an area that the Federal Emergency Management Agency has designated a disaster.
But to get a hardship withdrawal approved, the disaster declaration must include individual assistance. In other words, it's not enough that the area has been declared a disaster — "individual assistance" also must be available. And there's some debate whether Montana's coronavirus-related disaster declaration was designated for individual assistance, or just public assistance.
"The Montana governor's office sent an email stating Montana had been approved for state, public and individual assistance from FEMA," Dee says. But her husband's plan provider disagrees. "It's very frustrating."
Yet Hadley says it appears Montana has not yet been designated for individual assistance, just public assistance. But at the end of the day, "this is, in fact, an idiosyncrasy in the IRS hardship rules," Hadley says. "The coronavirus pandemic has revealed this quirk." No one really paid much attention to the nuance until Covid-19 hit, he adds, saying that the IRS only recently changed its rules around hardship withdrawals in the wake of federally declared disasters.
There are other ways Americans can get a hardship withdrawal approved — it doesn't always take a natural disaster. If you're facing eviction from your home or if you have overwhelming medical debt, for example, you can apply for withdrawal. But again, your retirement plan must provide for hardship distributions in the first place.
Other options if you need cash
With Montana on a phased reopening plan, Dee is hoping to head back to work at one of her jobs as early as the end of this week. "I will be going back...for one or two days a week depending on the need," Dee says. But the financial strain will linger. "I'm sure I'm not the only one in this situation," Dee says, adding that "little loopholes" are preventing many Americans like her from getting the financial assistance they need.
If you do need to dip into retirement savings and, like Dee, can't get the new CRD or a hardship withdrawal approved, you could see if your plan allows for 401(k) loans. These loans are not taxed, and you can take out up to $100,000 if you have been diagnosed with Covid-19, a spouse or dependent has been diagnosed or you can show that you've suffered adverse financial consequences as a result of the pandemic.
All 401(k) loans need to be repaid within five years with interest (this is set by your plan, based on the prime rate, which is currently about 3.25%), or you'll be hit with taxes. But if you leave your job early (whether you quit or are laid off), the outstanding balance often becomes due right away. You typically still need to be working at the company to take a loan, most plans do not offer 401(k) loans to former employees.
If those options don't work, you could also tap into a Roth IRA if you have one. With these accounts, you can withdraw any money you've directly invested into the account at any time, without taxes or penalties.
You could also consider applying for a personal loan from your bank, which is generally used to consolidate debt or make a big purchase. The average interest rate for a two-year personal loan was about 9.63% in February, according to the latest data from the Federal Reserve.
If you're unsure about what types of withdrawals are allowed under your 401(k) plan, Hadley recommends reaching out directly to your provider and ask specifically about coronavirus related distribution. Most providers also have online distribution tools. "If they're having trouble getting through to the call center, they should log into their account and see what's available in terms of online transactions," Hadley says. Also, consider contacting your employers' HR department directly. "They may be able to give you your answer a little more quickly," Hadley adds.
If you do get approved, keep in mind that you should limit your withdrawal to what you absolutely need. Many employers and plan providers are urging Americans to make a plan to repay the money and put some funds aside for next time there's an emergency, Hadley says. Even $5 or $10 a week can add up over time when you're trying to build an emergency savings fund.
"For most people, if the goal of the distribution is to help get you through a temporary loss of income, it would take most Americans a very, very long time to spend $100,000," Hadley says. Instead, take only what you need.
*Subject asked to be identified only by her nickname to protect her privacy.
Check out: The best credit cards of 2020 could earn you over $1,000 in 5 years
