Tapping Into Your 401(k)? Here’s How the CARES Act Could Impact Your Withdrawal

If you're thinking about cashing out your retirement account, here are some important things to consider.

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Updated May 13, 2024
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There’s been a lot of change happening in the world lately, and if you’re watching your 401(k) right now, the changes you’re seeing are likely a bit stressful. The ups and downs in the market and widespread spikes in unemployment all hint that we may be slipping into a recession.

Is it worth cashing in now or should you wait it out? If you’re asking yourself questions like these, we’ve got you covered. Here’s what to do with your 401(k) to prepare for a recession — and how the recent CARES Act might impact your financial decisions.

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What to do with your 401(k) during a recession

Don’t panic

Saving for retirement account is a long game. The markets go up and down daily, but it’s the overall growth over decades that you should focus on. The market will recover from any current losses, you just need to stay the course and wait for things to calm down.

Consider reducing your contributions

In general, it’s not best practice to reduce or stop your 401(k) contributions, but you might be concerned about emergencies or job loss. If you feel like you need to reduce your contributions and redirect a portion (or even all) of that money to an emergency fund, that might be the right move for you. Padding your emergency fund can help you avoid tapping into your 401(k) later and reduce your reliance on credit cards.

When the recession is over, if there’s excess savings, you can put that money into a retirement account. While there’s no substitute for consistent contributions, it might be better for your finances if you hit pause temporarily.

Weigh the options before cashing out your 401(k)

It may be tempting to turn the money you invested into cash that you can use to get by, but doing so might not be the best option.

Normally, you’d have to give up at least 10% of the money you’ve earned in taxes alone if you’re not yet 59 1/2. However, the CARES Act, passed to provide relief during the COVID-19 pandemic, temporarily waives the 10% penalty for those taking withdrawals due to the financial impact of the coronavirus.

The IRS also generally requires companies that manage retirement plans to withhold 20% of the balance when an early withdrawal is made. This helps ensure you can cover potential tax bills. That means if you have $20,000 in your 401(k), the most you might get in cash would be $16,000 — and your retirement account might be reduced. If you end up in a lower tax bracket, you could get that money back in the form of a tax refund later.

Consider a 401(k) loan

If you’re seriously thinking about dipping into your 401(k), consider taking a loan or applying for a hardship withdrawal instead. Your plan may have options for borrowing against the vested balance in your 401(k).

According to the IRS, under normal circumstances, you may be able to borrow up to 50% of the vested balance or $50,000, whichever amount is greater. The CARES Act doubles this, allowing you to borrow up to 100% of the vested balance or $100,000 during 2020.

You then pay back what you borrowed over time, usually with some interest, but you avoid early withdrawal penalties and still have a chunk of money earning for you throughout the life of the loan.

Note, however, that this can be a very risky move during a recession. Typically, your 401(k) loan becomes due immediately if you lose your job. So you could wind up on the hook. The CARES Act does allow for administrators to decide to postpone immediately due 401(k) loans for up to a year. But for now, it’s up to the administrator to decide if they will follow the CARES Act guidance.

Look into the 401(k) hardship distribution

Alternatively, the IRS also has a hardship distribution option, which can be considered when there is an “immediate and heavy financial need.” Each situation is different and your employer may or may not offer this as an option for your plan. Either way, it’s worth digging deeper to find out whether you can take advantage of this distribution.

The CARES Act has also modified tax regulations on 401(k) hardship withdrawals. If you withdraw money from your 401(k) due to COVID-19 in 2020, taxes on the amount withdrawn can be paid over the course of the next three years. The goal is to help make tax payments on withdrawals more manageable.

What to do with your 401(k) if you lose your job

Finally, if you find yourself without a job, you can either keep your 401(k) with the company it’s currently managed through or you can roll it into an IRA held elsewhere.

Even if you can keep your 401(k) with your old administrator, it might not be the best option for you. Some reasons to rollover your 401(k) include:

  • Fees: You might be paying high administrative fees with your old company. Many IRA custodians offer much lower fees, allowing you to keep more of your money.
  • Better investment options: With an IRA, you might have access to more investment options. If you want more direction over your retirement portfolio, moving the money can make a lot of sense.
  • Easier to manage: It’s easy to lose track of all your old 401(k)s. If you roll it over right away into an existing IRA, you can keep everything together.

Consider using a robo-advisor for your retirement portfolio if you don’t already have an IRA. Robo-advisors use algorithms and client data to generate recommendations for what to do with your money and when, as well as automatically make investments for you. Many robo-advisers, such as Wealthfront and Betterment, offer retirement account options with lower fees. This could save you money in taxes and keep your nest egg growing.

A final word of encouragement

Watching your 401(k) balance drop can be scary. But it’s helpful to remember you’re in it for the long haul, not the short term. The economy and your retirement savings will bounce back. If you’re in need of money now, look into a 401(k) loan and hardship benefits that may be available. But above all, relax and stay strong. You’ve got this.

Robin Kavanagh and Miranda Marquit contributed to this piece.


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