The "Cares act" allows $100,000 of 401k withdrawal without penalty. What are the reasons not to do this?

Question

From this website , we can pull out $100,000 from our 401k without penalty.

Distributions taken from qualified retirement plans received during 2020 of up to $100,000 for COVID-19 related purposes are allowed without a 10% penalty, taxable evenly over 3 years beginning with year of distribution

What are the reasons not to cash out our 401k? In my opinion, my would greatly benefit to have this money in real estate or other investments. We have already saved up about a $150k for a house down payment, and having $100k more would allow us to buy a house in our area outright or with a very small mortgage. Alternatively, we could put it into the S&P500 or Tbills, etc.

Edit: By "other investments" I mean something like a Roth IRA, which can be invested in similar stuff but with better long term tax implications.

Also, please note that prices of many investments will drop; so selling when its low is acceptable, assuming it is reinvested in something else that can also be purchased for cheap.

Answer 1

There are a couple reasons:

1. You don't qualify. From your link:

   Distributions taken from qualified retirement plans received during 2020 of up to $100,000 for COVID-19 related purposes are allowed without a 10% penalty, taxable evenly over 3 years beginning with year of distribution, and may be recontributed within 3 years. Related purposes include a COVID-19 diagnosis for you, your spouse or dependent, and financial hardship as a result of business closures, reduced work hours, lay off, furlough, lack of child care or other factors as determined by the Treasury Secretary.

   If this doesn't apply to you, you can't do this anyway.

2. Taxes. There is no penalty, but the withdrawal is still subject to taxes. You get to delay paying them, but they're at a higher rate than they would be if you withdrew at a slower rate and had no (or little) other income.

Additionally, you say

Alternatively, we could put it into the S&P 500 or Treasury bills, etc.

You could do this inside your 401(k) without having to pay income taxes (at least until you actually withdraw).

Answer 2

Getting money into qualified plans is difficult. Currently the tax law allows $19,500/year to be self contributed and in previous years it was less. It would take many years of maxing out contributions in order to catch up to withdrawing that amount.

You would be doing this at a time where your investments are significantly down. Will they rise again? History suggests so. Also you will owe tax on this money, so withdrawing 100K will likely yield around 70K or less depending upon your income. Spreading the tax over 3 years only lightly reduces the sting.

So unless you are in the very rare spot of having way over contributed to retirement savings there is no good reason to do this other than avoiding a bankruptcy or foreclosure.

So if you were able to save 100K in your 401K, what is preventing you from saving that amount outside your 401K and buying a home for cash?

Answer 3

1. It's a retirement account. You're putting money into it for a reason.

2. It's already invested. Paying the taxes now to convert it to a Roth IRA to invest the money seems backwards.

3. Selling securities during a huge market downturn is extremely bad for the long-term prospects of investing.

4. If your first thought at you can take money out of the retirement account without penalty is I should do that your retirement is not going to be enjoyable.

In summary I ask again: Why are you contributing money in the first place if you don't think the account is a good place for your money ?

Answer 4

A major reason to not withdraw is if doing so will cause your current investments in your 401k to be liquidated to whatever extent you withdraw. My understand is that this would normally be the case, even if you were to just borrow against your 401k. With current market conditions being what they are this may result in a substantial loss, possibly resulting in you "selling low". When the market comes back you will miss out on any gains in things that you are no longer invested in.

Answer 5

It's not allowed.

You cannot use this emergency rule to buy a house. It's not "a COVID-19 related purpose", as stated in your quote in your question.

The way tax regulation works is a) Congress passes laws, and b) IRS interprets the laws into regulations. Quick googling shows the law is passed but the regulations are not written yet. So you will be at the mercy of IRS's regulations, and that's no place to be.

Here's what one senator is saying. You have to have adverse financial consequences of some kind:

• You, your spouse, or dependent has been diagnosed with the coronavirus (i.e., SARS-CoV-2 or COVID-19),
• You have experienced adverse financial consequences because you have been quarantined, furloughed, laid off, or have had work hours reduced due to the coronavirus,
• You are unable to work because of a lack of child care due to the coronavirus,
• You own or operate a business and have had to close or reduce hours due to the coronavirus, or
• You have experienced an adverse financial consequence due to other factors as provided in guidance issued by the Internal Revenue Service.

IRS regulations will certainly flow from that. So you will find in 2021 when filling out your taxes, that you cannot tick any of the boxes, and thus your $100k distribution is treated as a regular distribution with 10% penalty and full taxes due on April 15 2021, and cannot be restored back into the 401K.

Other than that, this is a very robust 401K quasi-loan

The biggest worry when withdrawing from a 401K in a crisis is the contribution can never be replaced; thus you'd damage your savings and impoverish yourself in retirement. However, they wisely addressed this issue. If you qualify for this emergency withdrawal, you are allowed to put the money back in in the next 3 years, i.e. make an excess make-up contribution.

They are waiving the 10% for qualified withdrawals, and the income tax from a Traditional distribution will be spread over the next 3 years. You do need to pay tax on the distribution, but you are also allowed -- encouraged -- to "put the money back" as an excess contribution (beyond your normal annual $19,500 allowance, say). When you put the money back, you get the normal tax deferral, which cancels out the taxes due.

Say you take out $90,000 out of a Traditional due to a genuine crisis. Hospital bills or you will lose your house due to unemployment. You then pay taxes on $30,000 of it in 2021, 2022 and 2023. However you "put the money back", contributing $30,000 (beyond your normal $19,500) into the traditional in each year. That $30,000 re-contrib is a legit 401K contrib, and as such, has its taxes deferred. That deferral cancels out the taxes coming due.

And neat as a button, you are back to status quo ante. You got to "borrow" the money for 1-3 years, you put it back in good order, your net taxes are zero, and the money in your retirement account is fully restored (as far as the IRS is concerned. The market may have other ideas.)

It's a really brilliant scheme, I can't believe they came up with it in 2 weeks.

Wait wait wait. You just want to change to Roth!??

One of your ideas was to invest in a Roth IRA. Good idea, wrong method!

You can already convert your 401K to a Roth 401K. You can just pick up the phone and do it. There are no contrib limits, the only thing that limits you is the tax bracket you're willing to throw yourself into by doing so (and no offense I have a feeling this is all news to you; educate yourself a lot before doing anything big).

Now if your company doesn't offer Roth 401K, get with HR and tell them to get on the ball. Most companies now allow this.

Withdrawing from a 401K using this program to contrib to a Roth, would be a huge mistake full of disadvantages and lacking any advantages. Right off the bat, your contrib would be limited to $6000/year. 401Ks are absolutely protected from attachments, lawsuits and bankruptcy. IRAs, that protection varies by state and is sometimes nonexistent.

Answer 6

Here's a reason to leave it in 401k as long as possible: 401k is protected from bankruptcy and legal judgments

Answer 7

I can't even tell you good reason NOT to withdraw it, if you have it available. Unless I'm misreading things or misunderstanding what I've heard on tv, if you pay it back withing the 3 year period or roll it over to a similar account, there is no penalty to pay.

Honestly, this more than likely will be a time to be cash rich. I'm a Realtor and from speaking to a few lender partners, they've shared how tight the banks are becoming with their lending. Depending on how long this quarantine last, will most likely dictate how far things drop later. Having cash on hand will allow you to potentially pick up some cash flowing real estate for much less than you would have been able to this time last year. Maybe even multiple units! Buy low, Sell HIGH!

Answer 8

There is no definitive answer. In general, with or without the penalty, it is advisable to keep your 401k balance, because the eventuality of retirement and old age still remain, and you will still need that money as a living income. It should still be your last resort, given how difficult it is even in normal times to build your nest egg, against present day financial demands and impulses. At least if you need to tap into your 401k, it's preferable to borrow from it than to withdraw, since 401k plans seem to give a generous enough window to "repay yourself."