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So You Have Dipped Into Savings…What To Do Next With Your Retirement Account
Eileen Cozzi

Tapping an IRA, 401(k) plan or other tax-deferred accounts to pay current expenses can derail your retirement savings plan. Therefore, it should be viewed as a last resort. Unfortunately, many people reached that point in 2020 or earlier this year due to COVID-19’s financial impact.

If you withdrew or plan to withdraw tax-deferred savings as a result of financial hardship, you will need a strategy for getting your retirement plan back on track.

Related Read: Tapping Retirement Savings — But Only as a Last Resort 

Eliminating penalties

To ease some of the pain, last year’s CARES Act eliminated early withdrawal penalties for people affected by COVID-19 who withdrew up to $100,000 in retirement savings in 2020. The CARES Act also provided that account owners can avoid income taxes on the amount withdrawn by returning it to the account within three years.

Related Read: Senate Passes the Coronavirus Aid, Relief, and Economic Security (CARES) Act

Retirement plan owners unable or unwilling to return the funds have the option of reporting the distribution and paying applicable taxes in the year of the distribution or ratably over three years.  The Consolidated Appropriations Act, signed into law at the end of 2020, extended similar relief to certain non-COVID-19-related disasters, applicable to eligible distributions made on or after the date of the qualified disaster and before June 25, 2021.

Related Read: President Signs a New Stimulus Package

Serious consequences

To get an idea of how early withdrawals can affect your retirement plan, consider this hypothetical example. At the beginning of 2020, Pete is 35 years old and has a $200,000 balance in his employer’s 401(k) plan. He contributes $1,000 per month to the plan and expects to retire in 30 years. If his account earned an average return of 7% per year, his balance would be approximately $2.7 million at retirement.

In April 2020, Pete’s wife, Alicia, is laid off as a result of the pandemic. In July 2020, Pete takes a $75,000 distribution from his 401(k) plan to help cover the family’s expenses while Alicia looks for work. He also stops contributing to his plan until July 2021. How does a $75,000 distribution and a year-long suspension of contributions affect Pete’s anticipated retirement balance? The combined action reduces it to approximately $2.1 million — $600,000 less than his original projected balance.

Make up the loss

As you can see, taking an early distribution (even if it is penalty-free) from a tax-deferred account and suspending contributions can set you back. So, what can you do to make up for the loss in expected retirement benefits? Ideally, you would return the distribution to the account within three years to avoid taxes, plus contribute some extra to make up for any contributions and earnings you missed during the period of financial hardship. If that is not possible, think about increasing your monthly contributions by an amount that will enable you to achieve your original savings goal.

In Pete’s case, if he is unable to return the $75,000 distribution, he might still significantly reduce the tax by recontributing a portion of the distribution. If Pete recontributes approximately $1,600 per month beginning in July 2021, $38,400 of the distribution will be repaid within three years and Pete will avoid taxes on that amount. Pete will not be quite back on track with his original goals, but if Pete continues to contribute $1,600 per month to the plan, which is $600 more than the $1,000 per month contribution he was contributing prior to the distribution, he can get there.

IRS refunds

If financial hardship forced you to take an early retirement plan distribution, you are not doomed to a financially insecure retirement. Consider recontributing some or all of the distributed funds within three years or increasing your contributions to make up for the lost time. Be sure to amend your tax return if you report distributions as taxable income and later return them to the account within the three-year period. The IRS will refund you. Contact your ORBA advisor for advice on saving for retirement and minimizing taxes for your unique situation.

For more information contact Eileen Cozzi at [email protected] or 312.670.7444. Visit to learn more about our Wealth Management Group.

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