The CARES Act Provides Additional Relief Through 401k Plans

Please visit our COVID-19 resources page with more information for business owners and employees.

The CARES Act provides some relief to people affected by COVID-19 through their 401k plans. The new bill increases retirement plan loans and eliminates the penalty for early withdrawals to certain eligible participants.

All of the retirement relief provisions under the act are optional for plan sponsors to add. These options are available under the Nextep retirement plan. If you don’t have a Nextep 401k, you may contact your provider for guidance.

Penalty-free withdrawals

Generally, withdrawals from your retirement account before age 59 ½ result in a 10 percent penalty. The CARES Act eliminates the penalty and allows individuals, regardless of age, to withdraw up to $100,000 in 2020 for coronavirus-related reasons.

To be eligible for the penalty-free withdrawal, an individual, their spouse, or their dependent must be diagnosed with COVID-19 or suffer financial hardship (e.g. a reduction in work hours, unexpected leave without pay, loss of business) due to the outbreak.

Those who take the COVID-19 distribution have two options. They can treat it like an interest-free loan and repay the amount within three years from the date of distribution. With this repayment option, there are no tax penalties.

The second option is to treat the 401(k) distribution like an early withdrawal that won’t be paid back. Normally, there would be a 10 percent tax penalty for early withdrawals from a retirement account, but those who use this option under the CARES Act provision will owe ordinary income tax on the amount they take from their account, instead. The taxes can be paid over three years, or avoided altogether by going with the first option and replacing the withdrawn funds within the three year period.

Retirement plan loans & repayment

Participants who meet the coronavirus-related criteria may also be eligible to take out a retirement plan loan with a new loan limit. The CARES Act temporarily raises the limit on retirement account loans to the lesser of $100,000 or 100 percent of the participant’s vested account balance. If you already have a retirement loan, the act doesn’t allow you to take an additional loan, but you may be able to refinance.

With a retirement plan loan, unlike early withdrawals under the CARES Act, there is interest. However, the loan amount and interest are repaid to your retirement account. Interest rates are usually lower than a bank or lender loan.

If an individual doesn’t repay the loan on time, the amount borrowed is taxed as early distribution, and if you’re younger than 59 ½, you’ll also pay the 10 percent penalty for early withdrawal.

Participants with outstanding loan payments who meet the COVID-19 eligibility criteria can delay loan payments due from March 27 to December 31, 2020 up to a year. Interest continues to accrue during that time, and the plan can extend the term of the loan for up to one year.

Required Minimum Distributions (RMD)

The CARES Act waives required minimum distributions (RMDs) from retirement savings accounts for 2020. This means if you’re 70 ½ or older (born after June 30, 1949) in 2020, you can skip this year’s RMD to allow for account balances to recover. For more info about recent retirement legislation, check out our SECURE Act blog.

If a required minimum distribution has already been received during 2020, the participant may roll it over and defer paying taxes, including rolling the funds back into their plan. It is expected that the IRS will extend the 60-day rollover period.

If you have any questions about your 401k plan with Nextep, contact the retirement team at 401k@nextep.com.