Is the CARES package a gift or trap?Aug 04, 2020 09:27AM ● By Karen Telleen-Lawton
Always take a magnifying glass to a deal that allows you to borrow from what is already yours. I usually haul out this maxim for reverse mortgages, but it applies equally well to some provisions of the CARES Act—the coronavirus relief and stimulus package first passed in March.
Not surprisingly, the Act’s most hailed provision was the $1,200 cash payment to most workers.
Other provisions of the Act are much longer lasting. Specifically, CARES changes and adjusts the circumstances under which you can withdraw money from retirement accounts. It also allows you to delay your required minimum distributions. It’s up to your retirement plan sponsor, so check with them to see what they offer.
Even if your retirement account is eligible for loans, you must have a valid COVID-19 reason to access your funds.
COVID-19 eligibility for withdrawing retirement funds
• Being diagnosed with COVID-19
• A spouse or dependent diagnosed with COVID-19
• Experiencing layoff, furlough, reduction in hours or inability to work due to COVID-19 or lack of childcare because of COVID-19
Accessing retirement funds
If eligible, the new CARES rules provide for the suspension of penalties and taxes on early withdrawal and an increase in the amounts that can be withdrawn. For example, if you are not yet 59 ½ and intend to take a loan from your account for an approved COVID-19 reason, you will not pay the usual 10 percent penalty. You can borrow up to $100,000 (instead of the usual $50,000) or up to 100 percent of your funds (versus 50 percent).
If you repay the loan within three years, you owe no tax on the amount until you withdraw it again during retirement. If instead you take it as a permanent withdrawal, you can pay the tax all at once (which typically would reduce your tax liability) or over a three-year period.
This is both good and bad news. If you’re out of options, accessing these funds could be a temporary lifesaver. However, the purpose of retirement savings is to develop a nest egg. The pandemic is not likely to reduce your future need for retirement income. Therefore, anything you withdraw now you’ll want to replace as soon as possible.
Dr. Shlomo Benartzi, professor at University of California Los Angeles’ business school, says the way to take advantage of the loan without derailing your retirement is to develop and follow a repayment plan. He recommends these guidelines for making decisions about using your nest egg:
• Hardship withdrawal versus a loan. If your plan is to restore your retirement funds, a loan makes this easier by automatically setting you on a repayment plan. Trying to set aside the money outside of your retirement plan is less likely to be successful.
• How much to withdraw. Dr. Benartzi recommends you take out only half of what you think you need. You don’t want to feel flush, but instead observe anytime you’re spending your hard-saved funds. This attitude will save more of your funds as well as the option to withdraw more if absolutely needed.
• Rebuilding your portfolio. Stay enrolled in the paycheck deduction for your company retirement plan using your previous contribution percentage. Then, commit to increasing percentage contributions regularly. Benartzi recommends increasing your deduction amount two percentage points per year until you’re saving 15 percent a year. This is the highest percentage allowable under the Secure Act.
For those of us in our post-kid and pre-retirement years, I would suggest saving 20 percent or more of your income. A financial advisor can help you determine an appropriate rate for your circumstances.
Dealing with job loss
Illness, death and loss of livelihood are some of the terrible fallouts of this pandemic. Marooned retirement accounts may seem like the least of your worries. Nevertheless, they are important anchors for your future. There are three options for dealing with retirement accounts when you leave a company: cash them out, move them to IRAs, or leave them under the company’s plan sponsor.
If you have other accounts with a money manager such as Schwab or Fidelity, I recommend comparing management fees and investment options between the management selections. Likely you’ll pay less without sacrificing return by rolling your accounts to IRAs, but it means you’ll have to pay more attention. If this isn’t your forte, leave it with the company sponsor to manage.
In any case, do your best not to cash out your retirement for living expenses while you search for work.
Taking your RMD
For 2020, retirees are not required to take their minimum distribution. Moreover, the age by which you must make your first withdrawal is now 72 instead of 70. Leaving the money in your retirement accounts may allow time for the funds to recover from market gyrations. It also improves your future flexibility. One disadvantage is that you will withdraw funds in fewer years, which could result in you being in higher tax brackets.
Nevertheless, as with loans from your retirement, if you need the money, take the money. Withdraw it little by little, as allowed by the plan sponsor.
You’ve taken a lifetime to accumulate your retirement funds. COVID-19’s thrown a wrench in planning. If you move slowly and deliberately, you can make decisions using the CARES Act that will serve your needs now and maximize your retirement lifestyle.