Months of economic uncertainty have driven people to turn toward a normally forbidden pot of cash: their retirement savings.
The CARES Act, which President Donald Trump signed into law this spring, allows individuals affected by the pandemic to take emergency withdrawals of up to $100,000 from their retirement plans.
Savers under age 59½ can now withdraw the sums from their 401(k) and 403(b) accounts without the usual 10% early withdrawal penalty. This also applies to individual retirement accounts.
As more people lose their jobs and millions more face the risk of losing their $600 weekly enhanced federal unemployment benefit, savers have started tapping their retirement accounts.
Indeed, 17% of all distributions taken by savers between April 6 and June 26 were "coronavirus-related distributions," according to an ADP analysis of plans it manages.
At Fidelity, 711,000 individuals took a CARES distribution between April 1 and June 30, accounting for 3% of the company's eligible 401(k) and 403(b) plan participants.
Savers took a median coronavirus-related distribution of $4,800 from their plans, but some 18,600 participants asked for the full $100,000, Fidelity found.
Meanwhile, 2% of retirement plan savers at Vanguard took a coronavirus-related distribution through May 31. Of these, 4% were for the maximum amount of $100,000.
"It's a double-edged sword," said Kristin Andreski, senior vice president and general manager of ADP Retirement Services.
"There are many who had access to assets when they needed it, and now there's the other side: The consequences of taking it out of the market during volatile times and what do the next two years look like in terms of tax planning," she said.
Accountants deem a 401(k) or IRA withdrawal as a move of last resort, since savers are pulling from their nest egg to help pay current bills.
"It takes a long time to build up $100,000, and it's not easy to build it one paycheck at a time," said Ed Slott, CPA and founder of Ed Slott & Co. in Rockville Centre, New York.
As helpful as the Covid-19-related distribution might be to families in need, individuals plucking money from their accounts will need to prepare for the taxes they'll face.
"We've had people reach out, interested in exploring these options, but most of them don't fully realize the income tax consequences of taking the distribution," said Thomas Neuhoff, CPA at Henry & Peters in Tyler, Texas.
Normally, a withdrawal from your retirement plan would be subject to income taxes, plus a 10% penalty if you're under age 59½.
The CARES Act instead allows you to pay the taxes over three years.
Further, if you repay the funds within that three-year period, you won't be subject to these taxes. In that case, you will need to file amended tax returns for those prior years to show that the withdrawal was returned.
Last month, the IRS expanded eligibility for the coronavirus distribution.
Previously, savers could take it if they had Covid-19 or their spouse or dependent had the disease. It also covered those who were laid off, furloughed or had their hours cut, as well as those who were unable to work due to lack of childcare or entrepreneurs who closed their businesses.
In June, the IRS added to that list workers who had a job start date delayed or an offer rescinded due to Covid-19.
Further, if your spouse or a member of your household was furloughed, laid off or had their hours cut due to the pandemic, you're now eligible for the $100,000 distribution.
If you decide a Covid-19 withdrawal from your retirement savings is necessary, plan ahead:
• Take only what you need. "Consider your budget first, and don't take out the maximum if you don't need it," said Nicole Davis, CPA and founder and principal at Butler-Davis in Conyers, Georgia.
She recommends looking at the next three to six months and then reassessing your needs after that point.
• Know what you're getting into. While the CARES Act gives relief on the 10% early withdrawal penalty, you're still responsible for the income taxes.
While you can reverse the tax if you return the money in three years, "that doesn't always happen, especially in an era of uncertainty," said Slott.
• Start thinking about how you're going to foot the tax bill. This is especially important as your household finances shift in subsequent tax years. "If you have a complete loss of income in 2020, you might have very little taxable income," said Neuhoff. "But what about 2021 and 2022?"