When the CARES Act was passed in late March, it provided a lifeline for people who were facing financial constraints due to the coronavirus pandemic: the ability to take early retirement account distributions without penalty.
While we initially warned against making this move unless you’re truly in a tough situation, the amount of questions about the process for making these withdrawals—and eventually paying them back—indicated that many people had already considered their options for accessing cash and determined that a retirement withdrawal was their best option.
If you’re in that group, you might be wondering what you do once you’ve made a withdrawal from your tax-advantaged retirement account like a 401(k). Let’s go over some common questions about managing the next steps after you take an early distribution.
How do I pay back my distribution?
You’ll repay your distribution through a rollover contribution to the same account from where you took the money.
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If you take more than one distribution (say, you take out $10,000 and then another $15,000), you’ll have different three-year timelines for each of those distributions.
What about the taxes? How do I pay those?
Look for IRS Form 8915-E toward the end of the year—you’ll use it to report any repayment of your coronavirus distribution on your 2020 tax return. If you use an online service to file your tax return, they’re likely to be able to walk you through the fields of this form just like you would complete the rest of your return.
You generally have two options for paying the taxes due on any money you take out of your retirement account: You can break it up over three years, or have it all counted as income for this year.
Here’s the example the IRS gives: “if you receive a $9,000 coronavirus-related distribution in 2020, you would report $3,000 in income on your federal income tax return for each of 2020, 2021, and 2022.”
Why would you choose one option versus the other? It depends on your plan for the money.
If you intend to take your withdrawal as a temporary one, you don’t have to pay the entire income tax for that amount right away. But say you know you need this cash from your retirement account and you don’t know if you’ll be able to repay it in the three-year window. In your case, you can choose which income tax plan works better for you.
Here’s the other wrinkle in all of this, from another IRS example: Say you pay your income tax for your distribution over three years, but in the third year, you are able to pay back your distribution amount in one lump sum. You won’t have to pay income tax for that last year of your distribution, but in order to claim a refund for the income tax you already paid, you’ll have to file an amended tax return for the first two years.
Can company match contributions be applied to repayment?
Since your repayment must be made as a rollover contribution, the only funds you can use toward that repayment are your own.
If you regularly have money deducted from your paycheck to go into an employer-sponsored retirement account, that won’t count toward your repayment. You’ll either need to pause your regular contributions until you catch up with your rollover contribution (which may mean you miss out on an employer match) or make your regular contributions plus your rollover contribution.
What if I can only repay part of the balance before my three years runs out?
If you only repay part of the amount with withdrew, you’ll only be on the hook for the taxes on the remainder you didn’t repay. But you may still need to file amended tax returns to reflect the correct amount you ultimately end up keeping.
The nuances of taking a coronavirus-related distribution—plus guidance the IRS has yet to provide—drive home the importance of thinking through this decision before you start pulling money from your retirement savings.
While it may be your best bet for accessing cash during a tough period, it’s not a decision to make lightly. And it’s probably discussion best had with a financial advisor before making a final call.
