In 401(k) Plans for Small Business

The Coronavirus Aid Relief and Economic Security (CARES) Act is a significant piece of legislation representing nearly $2 trillion in support for individuals and businesses.  This is a massive spending bill.  To put this in perspective, this legislation represents nearly 10% of the entire annual GDP of the United States.

The CARES Act touches many important areas regarding unemployment insurance & small business support.  The degree of financial support to individuals that Americans will see in the coming months is unprecedented.  Normally, if a person is laid off and is eligible for unemployment benefits, that average weekly unemployment check is approximately $385/week.  However, during this crisis, the federal government will increase that unemployment check by $600/week, for a total of $985/week, for four months.  And this is just one of the areas of support.

Another area of support is loosening regulations around retirement plan distributions.  As a financial adviser, I strongly encourage everyone to think carefully as they explore their options during this crisis.  I can’t tell you how many people I’ve talked to that withdrew money from their retirement savings in 2008, only to see the stock market recover just a few years later.  If you want to retire successfully, your retirement account needs to be funded.  And with many anticipating that increased government spending on the horizon, it is hard to believe that higher taxes will not follow, perhaps significantly for some.  Finally, if you do face financial difficulties, there are distinct advantages of having money held in a retirement account versus a bank account.

Nevertheless, tapping into your retirement assets is an option in the financial management crisis toolkit.  I strongly encourage anyone considering this option to do it thoughtfully.  Please keep in mind that this is a very fluid situation and as of early April 2020 I believe this information to be accurate, but it may be subject to change.

Retirement Distribution Rules Have Been Significantly Loosened

One of the components of the CARES Act applies to loosening the restrictions on tapping into retirement savings to meet near-term needs.  The government has adapted a methodology that is frequently used for people affected by economic disasters (Hurricane Katrina, California wildfires, etc.).  Importantly, many features allow individuals to return the money back to the retirement plan after the crisis subsides.

You Can Now Request a Large Distribution before Retirement

If you request a distribution from your 401k account under the CARES Act, it qualifies for the following exceptions to current law:

  • Up to $100,000 distribution: Prior limit was $50,000. This is from any combination of IRAs or employer 401k plans.
  • Must be made in 2020: This includes distributions made since 1/1/2020. This may allow people who requested a distribution prior to the CARES Act to reclassify it as a related to the coronavirus, enabling more advantageous tax treatment.
  • Must be because of a COVID-19 issue: The rules are now broadly defined by the IRS and could be subject to change.  These include, but not limited to, being sick with COVID-19, a family member who is sick, unable to work due to lacking childcare, working in a business that is closed or operated under reduced hours because of the disease, etc.

Taxes and Fees Have Been Lowered on Distribution Requests

Many taxes and fees often associated with early withdrawals from retirement assets have been waived in 2020 for coronavirus-related distributions.  There are many tax advantages to designating a withdrawal as a coronavirus distribution, which include:

  • Exemption from 10% penalties: For people younger than 59 ½, a 10% withdrawal penalty is waived for these distributions under the CARES Act.
  • Not subject to mandatory withholding for 401k: Usually there is a mandatory 20% withholding charge assessed for taxes on distributions, however these are waived.
  • Eligible to be repaid over three years: Withdrawals can be “rolled back” into the account within three years of the date that the distribution was received, enabling the recipient to “replenish” their retirement account in the future.
  • Income is taxable, but paid over a longer time: The recipient can choose to have their withdrawal taxed over three years or all in 2020.   For instance, if $60K is withdrawn in 2020, then $20K could be counted as income in 2020-2022 or $60K in 2020.

Mid-Year Plan Changes Are Allowed in 2020:

401k plans can change their adoption agreement to include the following features that make it easier to access retirement money:

  • Maximum loan amount increased from $50,000 to $100,000: Loans can be an alternative to making a distribution.
  • 100% of vested balance may be used: In prior situations, loans were limited to 50% of vested balance.
  • Payments on plan loans may be delayed by one year: If you take a loan out, it is possible that the loan payments would not be due for one-year.

Please Think Strategically

If you are unclear about what your personal investment strategies should be during this unprecedented crisis, do not hesitate to reach out to your financial adviser.  If you need financial advise, please don’t hesitate to contact me. I specialize in 401ks for Seattle small business employees.

It is times like these that substantive financial advice is most valuable.  Now is not the time to be shy about asking questions and soliciting help.

Stay safe and healthy.  And wash those hands.

Recommended Posts