The Coronavirus pandemic and the subsequent lockdowns have financially devastated many Maryland families. If you've faced a job loss and are struggling to pay bills, you may be wondering if you can access your retirement savings to get through this rough period. While you may be able to access your retirement savings, you should also consider the long-term financial implications and the short-term tax consequences, including newly allowed retirement plan distributions and loans under section 2202 of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act).

What Should I Consider Before Withdrawing Retirement Savings?

Before withdrawing from your retirement savings account, you should consider:

· What type of retirement plan do you have? Most contributions to retirement accounts are not taxed until you withdraw them. The government does not tax certain qualified Roth account distributions.

· How old are you? You will face an early distribution penalty for many retirement accounts if you take money out before you are 59 ½ years old. The penalty is 10% for many plans, but for a SIMPLE IRA, the early withdrawal penalty can be up to 25% if you've only begun participating in the plan within the last two years. While the CARES Act does eliminate the 10% penalty for early withdrawal for some qualified distributions, you will still need to pay taxes on the withdrawal as income.

· How much do you plan to withdraw? The early withdrawal penalty you pay will be a percentage of the money you withdraw, so the more substantial the amount withdrawn, the larger the penalty.

· How will you use the money? You may not face an early withdrawal penalty if you use the money for things like buying a house or paying for college tuition or medical bills, depending on the type of retirement plan you have. But paying other bills will not qualify for an exemption to the early withdrawal penalty.

The Tax Consequences of Retirement Savings Withdrawals

Aside from early withdrawal penalties, there can be tax consequences if you withdraw a large sum of money from your retirement account. The IRS treats distributions from a retirement account as ordinary income. As a result, your yearly taxable income will increase by the amount of money you withdraw, and your marginal tax rate will increase.

The marginal tax rate is the rate at which you incur tax on an additional dollar of income. As of 2020, a married couple filing jointly will pay 10% in tax for the first $19,749 of income. The next $19,750 to $80,250 is taxed at 12% and so on, up to the top bracket of 35% for income over $414,700.

If your income for 2020 is $71,000 and you take $20,000 out of your 401K, your ordinary income will increase to $91,000. As a result, your marginal tax rate will increase from 12% to 22%. That means that your income over $80,250, or the last $10,750 of your income, will be taxed at 22%. If you add a 10% to 25% early withdrawal penalty to additional taxes, it may make financial sense to consider other options.

Consider Borrowing Rather Than Withdrawing Funds

The CARES Act provides some additional distribution options and favorable tax treatment for qualified borrowers for distributions from eligible employer retirement plans. Eligible plans include Individual Retirement Accounts (IRA), 401(k), and 403(b) plans. The CARES Act also increases the limits you can borrow from these accounts and allows additional time to repay the borrowed funds. You may qualify for the CARES Act borrowing or distribution options if:

· A medical professional diagnosed you or your spouse with SARS-CoV-2 or coronavirus disease 2019 (COVID-19)

· You suffered adverse financial consequences as a result of being quarantined, furloughed, laid off, working reduced hours, being unable to work without childcare, or closing or reducing the hours of a business you own as a result of SARS-CoV-2 or COVID-19.

· The 10% additional tax on early withdrawals will not apply to CARES Act-related withdrawals. You will need to include the amounts in your regular income over three years. You can also repay the funds as a loan if you do so within three years.

Contact Gabaie  for a free consultation about the financial and tax implications of withdrawals from your retirement savings at (410) 862-2198.