New Stimulus Bill Unlocks IRA and 401(k) Dollars for Financially Affected
The $2 trillion relief package provides penalty-free early retirement-account distributions and increases loan limits.
The coronavirus stimulus bill signed into law on March 27 creates new exceptions that allow 401(k) and IRA owners affected by the pandemic to tap into their retirement accounts early. The new law increases the dollar amount you can loan yourself from your own 401(k) from $50,000 to $100,000 and also creates a penalty-free early distribution rule whereby IRA or 401(k) account owners under age 59-and-a-half can take a penalty-free retirement account distribution of up to $100,000. These new rules greatly increase access to retirement account funds, which have become one of the most reliable savings tools. At the end of 2019, Americans held more than $30 trillion dollars in retirement accounts, according to the Investment Company Institute. That's right, trillions.
These new exceptions are among the many ways business owners, entreprenerus and self-employed persons can provide short-term financial relief. Just this past week, I had two separate conversations with business owners who had requests on how they can take a loan from their 401(k) to cover payroll costs and their own personal expenses amid significant revenue shortfalls. As the financial strength of Americans is being tested, many small-business owners and entrepreneurs are simply out of available cash and have limited lines of credit, but they may have a retirement savings account with funds that could help them survive. Tapping that resource could be the necessary short-term measure needed to bridge you or your business over until funding is secured from an SBA Disaster Assistance Loan, a home-equity line of credit or other long-term financing or equity investment.
Details of, and frequently asked questions about, the penalty-free, $100,000 early retirement distribution and increased 401(k) loan limit of $100,000 are more fully outlined below.
Penalty-Free Early Distributions Up to $100,000
Who Can Take the Penalty-Free Distribution?
The distribution rules are personal to the account owner and include anyone who has experienced "adverse financial consequences" from the pandemic. This is a broad definition and one that the account owner claims with their account administrator. Adverse financial consequences include being subject to a quarantine, being furloughed or laid off, having your business closed or hours reduced or being unable to work due to childcare changes and availability (closed schools, closed childcare facilities). The rule also includes anyone who has been diagnosed with COVID-19 or whose spouse or dependent is diagnosed with the virus.
What Accounts Qualify?
All retirement accounts fall under this rule. This includes IRAs, Roth IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, pension plans, 457 plans and 403(b) plans.
Am I Taxed on the Distribution?
The 10 percent early withdrawal penalty is waived, but you are taxed on traditional funds distributed. Congress did provide relief on the taxes on the distribution by allowing taxpayers to pay the tax owed on the distribution over three years. This is a significant benefit, as most retirement account distributions are subject to tax on the full amount in the tax year distributed. By paying over three years, you can spread the taxes due on the distribution over multiple tax years, which keeps you in a lower bracket and allows you to defer payment over time.
Can I Pay Back the Funds?
Yes. The special distribution provision allows you to pay back the retirement account over a three-year period. You can make multiple payments back to the account or one lump-sum payment to the account by the end of the three-year window. This is an excellent option, as it allows those who can get back on their feet financially to return the funds to their retirement account. And if you do, you'll avoid any taxes on the distribution.
How Long Is This Penalty-Free Option Available?
The penalty-free distribution option is available on qualifying distributions made from January 1, 2020 to December 31, 2020.
401(k) Loans up to $100,000
Who Can Take the Loan?
Anyone who has a qualifying employer plan, such as a 401(k) or 403(b) plan, and has suffered "adverse financial consequences" from the pandemic. The qualification rule is identical to the penalty-free distribution rule and the account owner themselves claims whether they qualify with their account administrator. Adverse financial consequences include being subject to a quarantine (most states/cities now), being furloughed or laid off, having your business closed or hours reduced, or being unable to work due to childcare changes and availability (closed schools, childcare facilities). The rule also includes anyone who has been diagnosed with COVID-19 or whose spouse or dependent is diagnosed with the virus.
These loans are not available on IRA or SEP IRA accounts. Also, a 401(k) with a former employer is usually restricted from taking loans by that former employer. However, some individuals with IRAs, SEP IRAs or former employer plans who are self-employed may establish a solo 401(k) and then roll IRA or SEP IRA dollars over to the solo 401(k) to take a loan from the solo 401(k) account under these special coronavirus rules. There's plenty of planning opportunities to those who need access to retirement account funds right now.
Are There Taxes Due on the Loaned Amount?
There are no taxes or penalties owned when you take the loan. And so long as you pay the loan back, it's a tax- and penatly-free opportunity to access your own retirement savings early.
How Much Can I Take?
Up to $100,000. The standard rule only allows individuals to take 50 percent of their vested 401(k) account balance (or other employer qualifying account), not to exceed $50,000. The special coronavirus rule not only increases the maximum loan amount from $50,000 to $100,000, but also removes the requirement that you can only loan yourself 50 percent of the account balance. These are two big improvements that will provide greater access to retirement account funds.
The differences are best understood by two examples. Under the standard rule, if you had a $200,000 401(k), you could take a loan of 50 percent of the account, not to exceed $50,000. This would allow you to take the limit of $50,000. Under the special coronavirus rule, with a $200,000 401(k), you could take the maximum of $100,000.
Let's consider another example and assume you have a 401(k) with a $70,000 vested balance. Under the standard rule, you could take a loan of $35,000 because you can't take more than 50 percent of the vested account balance. Under the special coronavirus rule, you can take 100 percent of the vested account balance and a loan of $70,000.
What Can I Use the Funds For?
By law, the loan can be used for anything you want. The funds can be used to cover personal financial expenses, business expenses like payroll or rent, new business startups, education expenses or any personal or business purpose you want.
How Long Do I Have to Pay It Back?
You've got five years to pay back the 401(k) loan, and it must be paid back in substantially level payments, at least quarterly, within five years. A lump-sum payment at the end of the loan is not acceptable.
What Is the Interest Rate?
The interest rate for 401(k) loans is currently 5.25 percent. By law, the interest rate to be charged is a "commercially reasonable" rate. This has been interpreted by the industry and the IRS/DOL to be prime plus 2 percent (prime is currently 3.25 percent). If the loan is for the purchase of a home for the account owner, then the rate is the federal home loan mortgage corporate rate for conventional fixed mortgages. Even though you are paying interest, you are paying that interest to your own 401(k), as opposed to paying a bank or credit card company. That's a plus, as you're repaying your 401(k) and getting the interest in the 401(k) too. Also, business owners who use a 401(k) loan to fund their business can expense the interest they are paying back to the 401(k). They can treat that interest expenses the same as interest they pay a bank on a business loan.
How Many Loans Can I Take?
By law, you can take as many loans as you want, provided that they do not collectively exceed the total loan amount. If you are taking a loan from a current company plan, some plans restrict you to one loan per 12-month period. There is also a fee under most plans for a loan ranging from $50 to $350, so make sure you check your 401(k) plan's loan rules and fees.
What Happens If I Don't Pay the Loan Back?
Any amount not repaid under the loan will be considered a distribution, and any applicable taxes and penalties will be due by the account owner. Most plans give you a grace period of one missed payment, but after that, the total amount owed under the plan is deemed distributed if you miss your payments.
How Long Is This New Increased Loan Option Available?
The new loan option is available 180 days from enactment of the law. The bill was signed into law on March 27, 2020, and as a result, the increased loan amount option will be available until September 23, 2020. Any loans taken outside of this time period are subject to the normal 50 percent limitation and the $50,000 loan cap.
Hopefully, this will provide all of us some relief.
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