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When the CARES Act was enacted in late March, it offered crucial support for individuals facing financial challenges due to the coronavirus crisis: allowing them to take early distributions from retirement accounts without facing penalties.
Although we initially cautioned against this decision unless absolutely necessary, the surge of inquiries about how to make withdrawals and eventually repay them showed that many people had already considered their options and found that a retirement account withdrawal was their most viable solution.
If you're among those who have made a withdrawal, you might be wondering what the next steps are after accessing funds from your tax-advantaged retirement account like a 401(k). Let’s walk through some frequently asked questions about managing the aftermath of an early distribution.
How can I repay my distribution?
To repay your distribution, you’ll need to make a rollover contribution to the same account from which the funds were withdrawn.
If you take multiple distributions (for example, withdrawing $10,000 and then another $15,000), you’ll have separate three-year timelines for each distribution.
What about taxes? How do I handle them?
Keep an eye out for IRS Form 8915-E at the end of the year—you’ll use it to report any repayments of your coronavirus distribution on your 2020 tax return. If you file taxes using an online service, it will likely guide you through completing this form just as you would the rest of your return.
When it comes to paying taxes on any funds withdrawn from your retirement account, you typically have two choices: Spread the tax liability over three years, or report the entire amount as income for the current year.
Here’s the example the IRS provides: “If you take a $9,000 coronavirus-related distribution in 2020, you would report $3,000 in income on your federal tax return for each of 2020, 2021, and 2022.”
Why might you choose one option over the other? It all depends on how you plan to use the funds.
If you expect your withdrawal to be temporary, you can delay paying the full income tax amount. However, if you're certain you’ll need the funds and are unsure whether you’ll repay them within the three-year period, you can select the tax plan that works best for you.
Here’s another complication, according to another IRS example: If you pay taxes on the distribution over three years but are able to repay the full amount in the third year, you won't owe taxes on the last year of your distribution. To recover the taxes already paid, however, you must file an amended tax return for the first two years.
Can company match contributions be applied to repayment?
As your repayment must be made via a rollover contribution, the funds used for this process must come from your own pocket.
If you typically have deductions from your paycheck going into an employer-sponsored retirement plan, those contributions won’t count towards your repayment. You will need to either pause your regular contributions until you've made your rollover contribution (which might cause you to miss an employer match) or contribute both your regular payments and your rollover amount.
What if I can only repay part of the balance before my three years runs out?
If you’re only able to repay a portion of the amount withdrawn, you will only owe taxes on the remaining unpaid balance. However, you may still be required to file amended tax returns to accurately reflect the amount you ultimately keep.
The complexities of withdrawing funds through a coronavirus-related distribution—and the additional guidance still awaited from the IRS—underscore the importance of carefully considering this option before tapping into your retirement savings.
Though it may be a suitable solution for securing funds during a challenging time, it’s not a decision to take lightly. Ideally, you should consult with a financial advisor before making a final decision.
