The CARES Act has relaxed the withdrawal rules on all tax-advantaged accounts. The list includes 401(k), 403(b), 457 and Traditional IRA. However, the CARES Act legislation only applies to qualified participants with a valid COVID-19 related reason for early access to retirement funds. Simply put, COVID-19 must have personally affected your life in order to be eligible for the special withdrawal rules. Valid reasons include:

  • Being personally diagnosed with COVID-19
  • Spouse or dependent diagnosed with COVID-19
  • Experienced a layoff, furlough or reduction in work hours
  • Inability to work due to COVID-19
  • Lack of childcare because of COVID-19

If one (or more) of these reasons is applicable to your situation, you can take advantage of the special withdrawal rules. What are the special withdrawal rules? From a financial standpoint, the most favorable rule modification allows you to make an early withdrawal from your retirement account without paying the 10% penalty. Of course, this rule modification only benefits those who are younger than 59 ½. In addition to suspending the early withdrawal fee, the CARES Act is temporarily eliminating the mandatory 20% tax withholding requirement. Please remember that the withholding is not a tax. Instead, it’s an attempt by the IRS to ensure that you pay the required income tax on withdrawals from your retirement accounts.

In addition to the favorable withdrawal rules, the CARES Act provides extraordinary flexibility in terms of redepositing the withdrawn funds back into a retirement account. The legislation allows up to three years to replace the funds. If you restore the funds within three years, no taxes are owed until the funds are withdrawn upon retirement. Typically, withdrawn funds must be restored within 60 days. Therefore, three years is an incredibly generous offer.

Always remember, your retirement accounts are designed to help you live a comfortable life upon retirement. Therefore, even if you qualify for the CARES Act withdrawal modifications, the best course of action is to avoid the temptation to pull money from your retirement nest egg. Funds should only be withdrawn in an emergency. If you find yourself in a financial emergency, by all means, you should take advantage of the CARES Act withdrawal rules.

What happens to retirement and 401(k) money that people lose when stocks plunge?

In order to answer this question, let’s use an example. Jane has $100,000 in her 401(k) account. Her entire balance is invested in a stock index mutual fund, which fluctuates in unison with the S&P 500 stock index. Over the course of the next 90 days, the S&P 500 index suffers a brutal decline of 35%. The value of Jane’s 401(k) falls to $65,000. Did Jane actually lose $35,000? If so, what happened to the money? Where did it go? Did the money simply vanish?

In response to the first question, the answer is “Yes.” Technically, Jane lost the money because her account balance declined from $100,000 to $65,000. However, if Jane did not sell her index mutual fund following the 35% decline, the loss inside her 401(k) is only a “paper loss.” If Jane had actually sold the mutual fund, she would have a “realized loss.” A paper loss is much better than a realized loss because Jane can recover her paper loss if the stock market rallies.

In response to the next group of questions, the best answer would be that Jane’s $35,000 disappeared or vanished. In other words, the value of Jane’s net worth declined by $35,000. She has less wealth today versus 90 days ago. This is a perfect example of why the Federal Reserve and Treasury Department are concerned about declining stock prices. When the stock market declines, many American consumers experience a reduction in their net worth. Additionally, the overall wealth of the American population declines. When people see their net worth decline, they are much less likely to buy goods and services. Of course, this has a negative impact on the US economy. This explains why our nation’s monetary leaders are constantly watching the movement of the stock market.