401(k) Tips

CARES Act 401(k) Withdrawals

The CARES Act allowed workers to take 401(k) withdrawals penalty-free. Taxes are still due but features of the bill can help ease the tax burden.

3 min read

If you withdrew money out of your 401(k) due to the COVID-19 pandemic, you might be able to get some relief come tax time. As a result of the pandemic, Congress has passed several bills to help Americans get through these difficult times. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was the first significant legislation passed after the pandemic hit. 

One significant feature of the CARES Act allowed workers of any age to withdraw up to $100,000 from their employer-sponsored 401(k) plan in 2020 and avoid the IRS’s 10% penalty tax. Standard income taxes on the withdrawal is still due; however, the tax bill can be spread out over the next three years, with one-third of the amount due on the 2020 tax return. Additionally, if you pay taxes on the amount and return the funds to your 401(k) by 2022, you can file an amended tax return and get your tax money back.

Eligibility to have the 10% penalty tax waived is reserved to those who tested positive for COVID-19 with a CDC approved test or faced financial consequences because you couldn’t work due to lack of childcare, your place of work shut down or cut your hours, or you were furloughed or laid off.

Penalties are waived but not income taxes.

It’s important to note that while the IRS’s 10% penalty tax for early retirement withdrawals is waived, income tax on the withdrawn amount is still due. However, the 20% automatic withholding from your 401(k) plan’s administrator is waived. It’s up to you to pay your tax obligation come tax time.

You and the IRS will receive a 1099-R for your 401(k) withdrawal. If Box 7 of the 1099-R has a “2”, it signifies qualified reasons for the withdrawal under the CARES Act. If Box 7 has a “1”, you’ll need a Form 8915-E in order to certify your distribution was qualified under the provisions of the CARES Act.

The tax bill can be spread out over three years.

Traditionally, when you withdraw funds from your 401(k), you’ll owe taxes the following year. In some cases, your 401(k) plan’s administrator will withhold 20% automatically to ensure you’re not faced with a large tax bill.

With the CARES Act, the entire income tax obligation is spread out over three years. A third of the tax bill must be satisfied after the first year, or April of 2021. The rest can be repaid in equal amounts in 2022 and 2023, or the rest can be paid all at once in 2023.

This is a huge help for those who were forced to withdraw funds from their 401(k)s in order to get by during the COVID-19 pandemic.

401(k) withdrawals can be tax-free if you repay the amount.

The taxes on your CARES Act 401(k) withdrawal can be avoided altogether if you are able to put the money back your 401(k) within three years of the distribution. The entire amount doesn’t need to be repaid all at once; it can be split into three payments. For example, if you withdrew $10,000, you could repay $3,333 a year for 2020, 2021, and 2022, or you can repay all $30,000 in year three. However, you’ll still need to pay your taxes tax year, but you’ll get your taxes back once and if the total amount is repaid.

To get your taxes returned to you, you’ll need to file an amended tax return. You won’t need to wait until year three to file the amendment. For instance, if you repay the full amount in the second year, you can file your amendment then and have your taxes returned.

401(k) withdrawals must be eligible under the CARES Act.

In order to be eligible for penalty-free 401(k) withdrawals, the CARES Act outlines some limitations.

First, 401(k) withdrawals are limited to $100,000. Secondly, 401(k) withdrawals must be a result of financial hardship due to the COVID-19 pandemic include:

  • If you or a member of your household tested positive for COVID-19 on a CDC-approved test, 
  • Or if you had financial consequences because of COVID-19 related conditions, including: 
  • Inability to work due to a lack of childcare.
  • Your place of work had to shut down, or your hours were cut substantially.
  • If you were furloughed or laid off.