Has a CARES Act retired? This is why it’s best to attempt returning it
Many Americans have financial problems following the coronavirus crisis. The CARES bill, passed into law in late March to provide relief, threw a bone off savers in the face of the financial upheaval caused by the pandemic. In particular, savers have been able to withdraw up to $ 100,000 from their retirement plans without incurring a penalty.
In general, withdrawals from an IRA or 401 (k) before the age of 59 1/2 are penalized with 10%. Under the CARES Act, this penalty does not apply to qualified withdrawals (i.e., withdrawals made by people specifically affected by the pandemic). Even if you had a good reason to withdraw money from your retirement savings at the beginning of the year, it is still worth putting that money back if you can.
Why should you try replenishing your retirement plan?
Although the CARES Act waives the 10% early withdrawal penalty normally applied to IRA or 401 (k) early distributions, it does not remove the tax burden associated with a payout. Traditional IRA and 401 (k) withdrawals are taxed as ordinary income. This applies in retirement and also under the CARES Act.
The CARES Act allows you to spread these taxes over a three year period, but you are still liable for them – unless you manage to get your payout back into your retirement plan within three years of taking it. Go this route and your tax liability will disappear.
However, it isn’t the only reason you should try to replenish your savings. The other reason is that if you don’t put the money back you could face a serious deficit by the time you retire.
The money in your IRA or 401 (k) doesn’t just sit there doing nothing. Rather, it is invested (or at least it should be).
Imagine that your retirement plan generally gives you an average annual return of 7%, which is a few percentage points below the stock market average. (This assumes a stock-intensive mix of investments, which you should have if you are many years away from the workforce.) Also, let’s say you made a $ 40,000 withdrawal under the CARES Act this year. If you’re 25 years away from retiring, not only will you be shy of $ 40,000 when your time on the workforce is up, but you’ll run out of $ 217,000 when you factor in lost investment growth.
If you desperately withdrew your retirement savings earlier this year, your finances may not have improved enough to be ready to pay that money back. But remember, you have three years to deposit these funds into your retirement account. So if your circumstances change for the better, this is an option worth pursuing.
While the pandemic is something most of us will likely never forget, it doesn’t have to be what’s killing your retirement. And if you manage to replenish your savings and avoid a tax burden, you will get away with it even more unscathed.