16 Feb Are COVID withdrawals a way to get funds out of my costly 401(k)?

Q. If I took a COVID withdrawal from my 401(k), I know there is no income tax due if it’s paid back to a qualified retirement account within three years. Is it correct that I don’t have to pay it back to my 401(k), which has horrendous fees? I’m thinking this could be a strategy to get the funds into an IRA.
— Investor

A. You may have several options.

Let’s go through how this all works.

Penalty-free distributions taken from qualified accounts under the CARES Act needed to be taken by Dec. 31, 2020 and only qualified individuals were eligible to take them.

Cynthia Aiken, a certified financial planner with Peapack Private Wealth Management in Bedminster, said a qualified individual is anyone who:

· is diagnosed, or whose spouse or dependent is diagnosed, with the virus SARS-CoV-2 or the coronavirus disease 2019 by a test approved by the Centers for Disease Control and Prevention (including a test authorized under the Federal Food, Drug, and Cosmetic Act);

· experiences adverse financial consequences as a result of the individual, the individual’s spouse, or a member of the individual’s household, including, those who are quarantined, furloughed or laid off, or having work hours reduced due to COVID-19; who is unable to work due to lack of childcare due to COVID-19; is closing or reducing hours of a business that they own or operate due to COVID-19; has pay or self-employment income reduced due to COVID-19; or has a job offer rescinded or start date for a job delayed due to COVID-19.

The IRS answers your specific question about qualified retirement accounts, Aiken said.

It said: “Normally, a hardship distribution is not an eligible rollover distribution. However, if the hardship distribution meets requirements to be a coronavirus-related distribution to a qualified individual, it can be recontributed to an eligible retirement plan.”

Aiken said this indicates that you could recontribute the funds to a different qualified account than the one from which the funds were withdrawn. However, she said, you should confirm that you are a qualified individual.

There’s something else you know know about, Aiken said.

Just before 2020 year end, Congress passed the Consolidated Appropriations Act of 2021 which included the Covid-Related Tax Relief Act of 2020 creating a similar and permanent retirement plan distribution exception called Qualified Disaster Distribution, she said.

“This exception allows withdrawals up to $100,000 aggregate per qualified disaster,” she said. “To qualify, an individual must have primarily resided in a qualified disaster area and sustained an economic loss from the qualified disaster.”

The type of penalty-free withdrawal offered in the CARES Act for qualified individuals impacted by COVID was not continued in this latest congressional act, she said.

However, if you were not a qualified individual for distribution purposes under the CARES Act, did not take a 401(k) distribution before 2020 year-end or do not live in a qualified disaster area, then you may have the option of taking an in-service distribution, Aiken said.

“An in-service rollover allows an employee to roll all or a portion of their 401(k) to an IRA while still employed with the company,” she said, but you need to see if your 401(k) plan offers this kind of provision and under what conditions you may take one.

“Some plans allow participants to take in-service distributions from amounts rolled over from a prior employer’s retirement plan,” she said. “It you do not meet the other conditions for taking a distribution and recontributing the funds back to a qualified account, then an in-service distribution may be your best option for rolling funds out of your 401(k).”

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This story was originally published on Feb. 16, 2021.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.