Are "Penalty-Free" 401k Withdrawals Free?
Mark Pettyjohn • June 9, 2020
On March 27, the government passed the Coronavirus Aid, Relief, and Economic Security Act, otherwise known as the CARES Act. The Act had a wide range of provisions to provide Americans and small businesses with economic support during the coronavirus pandemic. The bill provided stimulus payments, enhanced unemployment, and various forms of business loans.
One provision that flew under the radar was the ability for qualified individuals to take distributions from their 401(k) plans and IRAs without paying early distributions penalties. Normally, you face a 10% early distribution penalty if you take a withdrawal from these accounts before age 59 ½.1
However, under the CARES Act you can take up to $100,000 as a penalty-free distribution from your qualified accounts, assuming you are a qualified individual.2 Are you qualified? And even if you can take a distribution, is it wise to do so?
CARES Act Qualified Plan Distributions
Under the CARES Act, you can take up to $100,000 in qualified plan distributions if you are a qualified individual. Who is qualified? Anyone who meets the following criteria:
- You are diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention;
- Your spouse or dependent is diagnosed with SARS-CoV-2 or with COVID-19 by a test approved by the Centers for Disease Control and Prevention;
- You experience adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced due to SARS-CoV-2 or COVID-19;
- You experience adverse financial consequences as a result of being unable to work due to lack of child care due to SARS-CoV-2 or COVID-19; or
- You experience adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to SARS-CoV-2 or COVID-19.2
If you meet any of these criteria and you decide to take a distribution, you won’t have to pay the 10% early distribution penalty, even if you are under age 59 ½. However, you will still have to pay income taxes on the distribution. You can spread the taxes out over a three-year period, but you still have to pay them.2
Should you take a CARES Act distribution?
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It took just under five months for it to happen. On August 17th, the S&P 500 closed at 3389.78—an all-time record. That record is also significant because it means the index officially recouped all losses from the downturn that happened in March.
As the COVID-19 pandemic stretches into its seventh month, leaders in Washington are debating a second stimulus bill. On August 8, President Trump signed executive orders that extended the federal unemployment benefit, but reduced the amount from $600 per week to $400. The orders also suspended the payroll tax through the end of the year, and suspended interest on federal student loans.
The United States set a somber record on Thursday, July 16, 2020, with more than 75,000 new COVID-19 cases. In fact, the U.S. set new single-day COVID-19 records 11 times between June 17 and July 16. Dr. Anthony Fauci predicts the country will soon top over 100,000 new cases each day. 1 COVID-related deaths are also increasing in some states. Florida set its single day record for COVID deaths on July 16, with 156. Nine other states also set single-day death records the same week. 1 The resurgence in coronavirus cases has led some states to enact new measures. More than half of all states now have some kind of mask mandate. California has even rolled back its reopening, closing bars, indoor dining, gyms, and more. 2 What does this mean for the economic recovery? And what does it mean for your financial future? It’s impossible to predict what will happen in the short-term, but knowing where things stand today may help you make important decisions with your strategy.
