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401k Distributions Due to Coronavirus (CRDs)

401k distributions due to coronavirus

Photo credit: jb

Please note: this only applies to tax year 2020.

With the scourge of the coronavirus pandemic, many of us are in a serious financial position. In these dire situations, we may need to withdraw funds from retirement accounts early, in order to just get by. Thankfully, Congress passed a law recently, known as the CARES Act (Coronavirus Aid, Relief, and Economic Security Act of 2020, specifically section 2202) which provides a method for taking 401k distributions due to coronavirus related situations. These distributions are known as coronavirus-related distributions, or CRDs. (Note: I’ll refer to 401k throughout, but unless otherwise specified, these rules apply to IRAs, 403b and 457 plans as well. In addition, there are many more provisions in CARES that apply to retirement plans, economic relief payments, etc., but we’re only covering the CRDs here.)

The CARES Act provides a new exception to the 10% early withdrawal penalty on retirement plans, specifically if you have been impacted by the coronavirus.

Normally, if you wanted to withdraw money from your 401k prior to age 59½, your plan would prohibit such a withdrawal unless you have terminated employment, the plan has terminated, or you have experienced a documented “hardship”. And typically, unless you meet one of the exceptions noted in this article – 16 Ways to Withdraw Money From Your 401k Without Penalty – you will be assessed a 10% penalty on your withdrawal prior to age 59½.

With the introduction of this new exception for 401k distributions due to coronavirus, you may be* allowed to withdraw up to $100,000 from the 401k account, regardless of your age, without penalty. In addition, there are special rules regarding how the 401k distributions due to coronavirus are taxed, as well as special provisions for payback of the funds. We’ll get to those special rules and provisions a bit later.

* Like many provisions surrounding 401k plans (and 403b and 457 plans), the plan must specifically offer these special distributions due to coronavirus. There is no requirement that plans must offer them, so you’ll need to contact your plan administrator to find out if yours does allow the distributions due to coronavirus. Since this Act was just recently passed, your plan may allow the special distributions in the future but may not have amended the plan just yet.

What is “impacted by coronavirus”?

How do you know if you’ve been sufficiently “impacted” by coronavirus to qualifity for this special treatment of 401k distributions due to coronavirus? In order to qualify, the recipient of the distribution must meet one of these descriptions:

  • Individual, individual’s spouse, or individual’s dependent (for tax purposes) is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved byt the Centers for Disease Control and Prevention. 
  • Individual experiences adverse financial consequences as a result of being quarantined, or furloughed, laid off, or work hours reduced due to the pandemic.
  • Individual is unable to work due to lack of child care resulting from the SARS-CoV-2 or COVID-19.
  • Individual must close or reduce hours of a business that he or she owns due to the coronavirus.
  • Or other factors determined by the Secretary of Treasury.

The first bullet in the list is very specific and defined: you, your spouse, or your dependent must have been diagnosed with the specific virus by a specific test in order to qualify.

The remaining items are much more subjective and lacking in definition. It is not defined what is meant by “adverse financial consequences”. The good thing about this is that the Treasury is allowing individuals to “self-certify” whether or not “adverse financial consequences” have occurred. Plus, the adverse financial consequences may have occurred after the withdrawal – there’s no specific timeline for the activities, simply that the distribution due to coronavirus occurs in tax year 2020.

The child-care issue is obvious and probably the easiest for parents to meet – since pretty much all schools have canceled in-person classes, this leaves parents in the position of having to find or supply supervision for their children when they would otherwise have been attending school.

And the small business owner is covered with the fourth bullet – but I think it’s clear that the closing or reduction of hours of a business would also produce adverse financial consequences as covered in the second bullet.

The last bullet in the list is, of course, a catch-all providing leeway to the IRS in order to deal with unknown factors that may crop up. Since the CARES Act was slammed together pretty quickly, it’s more likely than not that there will be much need for additional guidance from the IRS on the implementation of these provisions.

How to take 401k distributions due to coronavirus

So now we know the specifics of how to qualify. Taking the distribution is the next step (assuming you qualify, need the distribution, and your plan allows it).

These distributions can be a single distribution or multiple distributions, depending on your circumstances. The only limitation is that the 401k distributions due to coronavirus are only qualified* up to $100,000 during the 2020 tax year. If you withdraw more than $100,000, presumably the excess would be penalized the same as any other withdrawal prior to the passage of the CARES Act.

Any tax-deferred money that you withdraw from your 401k plan will be taxed. Post-tax money, including Roth 401k funds and excess non-deducted 401k contributions, would be tax-free from such a distribution.

Another provision of CARES that helps out: normally a 401k distribution would be subject to an automatic (non-optional) 20% withholding for taxes. CARES eliminates that withholding by default. You are still allowed to designate a portion of your 401k distribution due to coronavirus as withheld for tax (which is probably a good idea if you don’t intend to pay it back).

* By qualified, I mean that those funds are exempted from the 10% early withdrawal penalty if you’re under 59½, as well as given the option of spreading the tax out over three years, plus are entitled to utilize the “payback” provisions. If you’re over 59½, there would be no penalty anyhow, but you may qualify for the other provisions.

Taxation of 401k distributions due to coronavirus

As mentioned above, any tax-deferred money from these distributions will be subject to ordinary income tax. That is, the tax-deferred amount of the withdrawal will be added to your other earned income for tax year 2020 and taxed as ordinary income. This is the same treatment that would always be applied when you take a distribution from your 401k.

What’s different about the 401k distributions due to coronavirus is that, by default, you are allowed to split up the tax over three years. This means that, unless you specify otherwise, 1/3 of your distribution will be included as ordinary taxable income on your 2020 tax return (due in 2021), and then 1/3 will be applied to your 2021 return, and 1/3 on your 2022 tax return.

In many (if not most) cases, this splitting of your tax hit will be the best way to go. However, if your income has been significantly reduced in 2020 and is expected to rebound in 2021, you might want to recognize this distribution as income solely in 2020.

For example, let’s say your normal income is $60,000 per year and you are significantly impacted by coronavirus in 2020, such that your income is expected to be about $20,000 instead. You take advantage of the special rule regarding 401k distributions due to coronavirus, withdrawing $30,000.

If you believe that your income will bounce back to $60,000 in 2021 (or more), then it might make sense to include the full $30,000 withdrawal as income in 2020, since that would put your total income at $50,000 for the 2020 tax year. Otherwise, by splitting the income over 3 years, you’d have $30,000 income in 2020, and $70,000 (or more) in 2021 and 2022.

What isn’t clear is whether you can include, for example, 50% of the income in 2020, and then the remaining 50% evenly between 2021 and 2022. Guidance from the IRS will eventually address this, I’m sure.

In addition, it’s not yet clear whether the decision to pay all of the tax in 2020 is an irrevocable decision. I doubt that it is – presumably you could amend the 2020 return after that decision and only pay tax on the default 1/3, since there will have to be provisions for amending these returns in the event of repayment after 2020 (see below for more).

The payback provision

What I believe is the most valuable provision in CARES with regard to 401k distributions due to coronavirus is the payback provision. Effectively, this special distribution (or distributions) allows you 3 full years to change your mind, and pay back all or a portion of the money you’ve withdrawn.

Normally, you only have up to 60 days to pay back any money withdrawn from a 401k or IRA. Plus, with a 60-day rollover (as this maneuver is called), you must be careful not to breach the one-rollover-per-year rules. However, under CARES, your time limit is extended to 3 years after the withdrawal, and the one-rollover-per-year rules do not apply.

A few things you need to understand about this provision:

  1. The payback is 3 years from the date of the distribution. If you’re intending to pay back the funds withdrawn, you’ll want to put a big red X on your calendar on the date 3 years from the distribution. Otherwise, you may mix it up with the tax payment provision and think that you have until the end of the 2022 tax year to complete the payback.
  2. If you take more than one qualified coronavirus-related distribution in 2020, each distribution will have a different 3-year period for payback. You’ll need to pay attention to these time limits if you’re paying back – see #1 above.
  3. There is no hard and fast rule about the payback – you can decide not to pay the money back, or pay back all or a portion of it during the 3 year period. 
  4. You also may make smaller, periodic payments back into a qualified account – there’s no requirement to pay it all back at once.
  5. Effectively this is a 3-year no-cost loan – other than the intermittent tax payments (that you’ll get back if you repay it all) and your cost of lost tax-deferred gains on the money withdrawn.
  6. The payback is to be made to any qualified retirement plan – so if you took the money from a 401k, you could re-pay the money back into any of the following: the same plan, a new employer’s plan, or an IRA. Note that you could also pay this money via a conversion into a Roth IRA if you wish.

When you pay back the money into an IRA or employer’s plan as tax-deferred, you’ll need to go back and amend the tax returns from prior years that included this money as ordinary income. You’ll do that by filing a Form 1040-X, removing the taxable portion of the 401k distribution due to coronavirus that you are paying back. This could result in a couple years’ worth of tax returns to amend.

Presumably (again, we’ll need IRS guidance on this) if you pay back only a portion of the distribution, you’ll be allowed to amend your return to ratably remove a portion of that income from your prior tax returns.

As mentioned above, these paybacks do not trigger the one-rollover-per-year rules. The CARES Act provision specifically statest that these paybacks are treated exactly the same as a trustee-to-trustee transfer, which is not subject to the one-rollover-per-year rules.

If you were paying attention in #6 above, you’ll notice that I mentioned above that it’s okay (at least presently) to convert your 401k distribution due to coronavirus to a Roth IRA. This might open up some abuse of the system – but at least until we hear otherwise from the IRS, it seems like a viable path.

Effectively, one could convert $100,000 from tax-deferred (like a 401k or traditional IRA) over to a Roth IRA, and then spread out the tax hit over 3 years. I’ve seen one highly-regarded IRA expert’s opinion on this, and it is her expectation that the IRS will get wind of this (if it becomes abused) and either require income inclusion in the year of a conversion to Roth, or possibly even disallow Roth IRAs as a destination for the payback. Stay tuned on this one.


  1. Barry Ramesar says:

    Will this be something that the new Bill President Biden is passing will seek to replicate in 2021?

    1. jblankenship says:

      The current stimulus package does not include a provision for early non-penalty withdrawals from 401k plans as was the case for 2020. I wouldn’t count on this happening in 2021 unless something drastic happens.

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