Pandemic-driven laws eased tax burdens on loans and withdrawals from 401(k) and IRAs, leading some clients to tap into their retirement accounts while many others avoided a raid

June 22, 2021

In the COVID-ravaged economy, Americans avoided tapping into their retirement plans to meet daily living expenses. Or they did the opposite, conducting mini-raids on their 401(k)s and IRAs for needed cash.

Data on how the pandemic impacted retirement nest eggs since it first unfolded in early 2020 is all over the map.

In the kept-your-hand-out-of-the-till category, Fidelity Investments found that in the first three months of this year, the percentage of workers with an outstanding 401(k) loan dropped to 17.5% from 19.7% in the same period of 2020, when the pandemic began. Only 1.6% of 401(k) savers took out a new loan — the same as in the fourth quarter of 2020, and down from 2.4% on year-ago levels. Fewer workers made 401(k) withdrawals, including for hardship, in the quarter — 2.4%, well below 6.1% in the last quarter of 2020 and 3% a year ago. Sums were small: the average hardship distribution was $3,900, and the median amount was $1,000.

Some Americans borrowed from their retirement accounts or took cash out to meet living costs during the pandemic.

Some Americans borrowed from their retirement accounts or took cash out to meet living costs during the pandemic.

Bloomberg News

In the raiding category, a December 2020 survey by Kiplinger found that roughly one in three older American workers either withdrew or borrowed money from their 401(k)s or IRAs to take advantage of temporary tax benefits. Among those people, 27% borrowed from their retirement accounts, while 31% made withdrawals.

In the somewhere-in-between category, Principal Financial Group, a large provider and recordkeeper of retirement plans, found that COVID-related hardship and disaster withdrawals were down 30% in the first three months of this year compared to a year ago. But amounts taken out rose 20%. Requests for loans dropped 25% — but those who did take loans asked for 12% more.

Amid the welter of statistics, here’s what advisors with clients who tapped into their retirement savings need to know:
Federal legislation last year eased tax restrictions on withdrawals and borrowing from retirement plans. The CARES Act, passed in March 2020, temporarily doubled the amount individuals could borrow from their 401(k)s, up to $100,000, when used to meet COVID-related challenges. For hardship loans and withdrawals, the law also scrapped the 10% early withdrawal tax penalty for those under age 59½. Individuals had to make withdrawals, if their plans allow them, by September 23, 2020. For loans, it also eliminated the ordinary taxes owed if the borrowed money goes back into the accounts within three years.

The law also waived required minimum distributions (RMDs) from tax-deferred retirement accounts, including regular 401(k)s and traditional IRAs, for last year and 2019, if the latter were taken by April 1, 2020.

COVID also upended the rules on inherited IRAs. In December 2019, another law, the SECURE Act, said that beneficiaries who aren’t spouses have to empty out the inherited accounts within 10 years. The issue is that if they’re still in their peak earning years, a withdrawal — either annually or in one fell swoop — can create larger personal tax bills and thrust them into a higher tax bracket. The law also raised the age, to 72 from 70½, at which owners of traditional retirement plans must take their first RMD.

Like its predecessor, the higher age is a hard stop: Not taking an RMD can leave you footing a tax penalty equal to 50% of the amount that should have been withdrawn. After confusing many advisors, the IRS clarified last month that non-spousal heirs to IRAs don’t have to take annual RMDs, and can instead cash out at any time within the 10-year window.

All told, COVID spawned incentives to tap into retirement funds — but it also created reasons not to. The government’s three stimulus checks swelled bank accounts. The cash payouts came as Americans cut back spending and stockpiled cash at record rates. Americans’ personal savings rate, which is income after taxes and spending, catapulted to 33% in April 2020, an all-time record, according to Bureau of Economic Analysis data. It’s now back to just under 15%.

Advisors typically view taking money out of retirement funds as a move of last resort. That’s because it diminishes the pile on which investment gains can grow over time. At the same time, the strong stock market has blunted some of that longer-term pain for clients who did take some money out.

Here’s what some experts and advisors see and recommend (edited for clarity):

Renee Schaaf, President, Retirement and Income Solutions at Principal:
“From among Principal’s participant pool, about 6% of people in plans with coronavirus-related distributions available took a withdrawal, with the average request being slightly below $17,000. The good news is that we see positive signs that participants are returning to long-term savings. We also see a silver lining in the impact COVID-19 seems to be having on people’s approach to retirement planning. Our recent surveying shows that 27% of workers are creating financial goals based on their estimated retirement expenses, up from 13% in 2018.”

Howard Hook, a CFP and CPA with EKS Associates, an RIA in Princeton, New Jersey with more than $218 million in client assets as of the end of last year: “For clients who would otherwise have had to have taken an RMD from an IRA or 401k, we recommended not taking the distribution if they did not need the funds or had another more tax efficient place to take the funds from. In addition to paying less tax, this had an added benefit for clients on Medicare, since the lower taxable income in many cases resulted in lower Medicare Part B premiums (premiums are income based). Lower taxable income in 2020 results in reduced Part B premiums in 2022.” With the new IRA 10-year rule, known as the demise of the stretch IRA, “many people are faced with questions on whether to take withdrawals each year or wait until the last year, or how much to take each year. There are tax consequences.”

CFP and CFA Clark Kendall, the president and CEO of Kendall Capital Management, an RIA in Rockville, Maryland, that caters to what it calls “middle-class millionaires,” with at least $500,000 in investable assets: “I haven’t seen clients take money out to live off of. For clients that did need funds, we used other avenues, like a taxable (for example, brokerage) account. We also talk about the advantages of a home equity line or a margin loan against a stock portfolio. The last thing we recommended was taking a loan from a 401(k). I consider the demise of the ‘stretch’ IRA an opportunity. You can delay the withdrawals. People thinking of retiring over the next 10 years can wait to take the money out. If you do so after you retire but before Social Security starts, it can be a terrific opportunity.”