Americans can now tap 401(k)s without penalty. Here’s how it works.
Amid the COVID-19 pandemic, the federal government has changed the rules on tax-protected retirement plans so people can take money out without penalty and put it back when their cash flow returns.
It’s part of the $2 trillion economic stimulus package that should be getting more attention. But care and reflection are needed to avoid trading off hardship now for hardship in future retirement.
“The standard advice is you don’t tap into this money, because you’re not going to have money for retirement,” Marketplace’s Chris Farrell said. “But so many people are going to be hitting the wall.”
The following is an edited transcript of Farrell’s conversation with “Marketplace Morning Report” host David Brancaccio.
David Brancaccio: The old rule was a hard and fast rule. You couldn’t take your retirement money out that had been tax protected if you were under 59 1/2 years old without this whopping penalty. But if you look carefully in the big stimulus plan that came out of Congress, they’re changing that?
Chris Farrell: They’re absolutely changing that. So the penalty was 10%. Plus, you would pay ordinary income taxes on the amount you took out. So now with the new rule, what they’re saying is, no penalty. And, by the way, you can pay the taxes that you owe on the amount that you’ve withdrawn, you can spread it out over three years. Or you can actually put the money back over those three years. So what they’re basically saying is, you can withdraw, without penalty, up to $100,000, from your 401(k), if it’s related to the coronavirus. And, by the way, that definition of “related,” it’s really broad.
Brancaccio: All right, so for people lucky enough to have retirement savings, which is certainly not everybody in America, this could be a crucial lifeline during this terrible stretch in the economy. But we have to remind ourselves, that money was being saved for a reason: your retirement.
Farrell: I know. And here’s the thing, the standard advice is you don’t tap into this money because you’re not going to have money for retirement. But so many people are going to be hitting the wall. And so when you run through your list of priorities, this is a pool of money. [To pay your bills,] you’re going to tap into your retirement savings. One of the things that we’ve been talking about is thinking about what might be some of the longer term implications of this. And I think this really highlights that people need a pool of savings that they can tap into in an emergency. And there has been this push for employers to offer that kind of plan.
Brancaccio: So what we’ve been talking about is already in the law, but what you’re about to talk about is on a wish list, how would it work?
Farrell: It would let employees meet their short-term financial needs you. The employee would be automatically enrolled into this employee-sponsored payroll deduction, rainy day fund, or emergency savings account, or sidecar account. And this could be tapped at any time for any reason to pay the rent or mortgage, the utility bill. But the key is that it’s through payroll deduction.
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