As this is written, the bill has not yet passed the House of Representatives, but the CARES Act probably will be law before the week’s end. The newest federal stimulus package is renowned for the distributions it is scheduled to make to families earning less than $100,000 per year. That topic has been much reported. What has secured less notoriety are provisions allowing hardship withdrawals from IRAs and hardship 401(k) loans. Again, the bill is not final and it is going to involve some regulatory gymnastics by the IRS but here is what is in the offing.
If you are “affected” by the Coronavirus either by being diagnosed with it or you have been laid off, fired or furloughed during this time, keep records of any documents confirming that. This may even include a notice that your daycare closed requiring you to stay home. These events may permit you to tap either your IRA for a distribution or your 401(k) for a hardship loan. Step 1 is what you can do today, which is retain the documents that may qualify you for this special form of taxpayer relief.
An IRA distribution made flat out does little for you from a tax viewpoint. The withdrawal is still “income” in tax year 2020 but the withdrawal is not going to be subject to the 10% penalty for those under 59.5 years of age. The legislation also appears to allow you to avoid tax consequence if you repay the distribution or loan within three years. That’s big and a possible lifeline for distressed families and small business holders. The limit is $100,000, but even if it is not back in the retirement kitty in three years, the plan is to allow you to report the income over three separate tax years rather than all at once.
What makes this provision so important is that no one is yet certain just how quickly the stimulus checks/deposits will be issued. It seems fairly certain that no states have the capacity to promptly process and pay 3 million unemployment claims. Truth is that you may have to reach for the IRA/401(K) remedy before all the regulations are issued in order to keep food on the table or your business alive. Obviously that does entail some risk that you will pay ordinary income rates (if you do not conform to all the rules-some probably not yet written). Understand however that these funds are not supplementing income, but substituting for income your employer is not paying you.
One other disadvantage to this plan merits attention. Sadly, if you take the money out now, you do so at a time when the S&P500 has fallen by 20% since New Year’s Day. Thus, you may be able to take out only 80 cents on the dollar you put into retirement at the end of December because that’s all your dollar is worth today. Desperate times require consideration of desperate measures and every captain’s first task is to keep the ship afloat.
“Don’t give up the ship.” Try to talk with both your tax adviser and your retirement plan manager about how best to make use of this life preserver without causing more damage to your long-term financial security. In the meantime, stay well.