Impact of COVID-19 on 401(k) Withdrawals

In 2020, over 36 million Americans were out of work, laid off or furloughed as employers closed their doors to help stem the spread of novel coronavirus pandemic. As people looked for financial lifelines, one starting point was their retirement plans. In March 2020, the coronavirus relief bill made temporary changes to the CARES Act that impacted early 401(k) withdrawals. 

401(k) Hardship Withdrawal: How Early 401(k) Withdrawals Work Under Normal Circumstances

A 401(k) Hardship Withdrawal is an early withdrawal from a 401(k) account to pay for an “immediate and heavy financial need. Under normal circumstances, withdrawing money early from 401(k) comes with consequences: a 10% penalty paid on all of the money you withdraw, in addition to paying normal taxes.

CARES Act 401(k) Withdrawal Rule Changes

Congress passed the $2 trillion Coronavirus Aid, Relief and Economic Security (CARES) Act on March 27, 2020 in its second round of pandemic-driven economic rescue measures. It was designed, effective this year only, to relax rules and penalties around early withdrawals from IRAs or 401(k)s and limits on 401(k) loan amounts. Under COVID 401(k) withdrawal rules:

COVID 401(k) withdrawals are worth investigating, but not guaranteed. Plan providers consider the 401(k) withdrawal COVID exemption as an optional plan feature. It means that offering the coronavirus-related distribution (CRD) is viewed as a “plan event” that requires the employer’s sign-off.

Further, not all plan sponsors are moving ahead to implement CRDs. A study by the Plan Sponsor Council of America found that nearly 70% of large organizations were allowing CRDs up to $100,000, or 100% of the vested amount in the account. But only about one in five smaller employers were allowing COVID 401(k) withdrawals.

COVID-19 Early 401(k) Withdrawal Penalty

The CARES Act rule changes allows people to take up to $100,000 out of a retirement plan without incurring the 10% penalty. They should be forewarned, however: Their employers must approve withdrawal requests.

Is a 401(k) loan better than a COVID 401(k) withdrawal?

The millions of people struggling to pay their bills today may not be thinking about their ability to retire in five, ten or 25 years. But that’s an important consideration.

In normal times, financial advisors recommend taking 401(k) loans rather than withdrawing account funds early. The amount removed is restored – eventually. That offsets the risk of coming up short on funds at retirement. But if the loan isn’t paid back on time, it’s treated as an early withdrawal subject to the normal 10% penalty.

As a COVID 401(k) withdrawal, though, the 10% penalty is removed. Since the funds are still gone and the potential financial gap at retirement remains, those that treat the withdrawal as a loan can end up in a better position: The funds they need now, no penalties, and the flexibility to pay it back over time, on their terms.

HUB Retirement Services help provide guidance on your plan’s setup and management to ensure it meets regulatory compliance guidelines and the interests of your employees regarding 401(k) withdrawal due to COVID.

*HUB Retirement and Private Wealth employees are Registered Representatives of and offer Securities and Advisory services through various Broker Dealers and Registered Investment Advisers, which may or may not be affiliated with HUB International. Insurance services are offered through HUB International, an affiliate.

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