If you have a 401K or an IRA retirement account, you may have heard that the 2020 CARES Act allows you to withdraw up to $100,000 without incurring the 10% early withdrawal penalty. Under the CARES Act, an early withdrawal should only cover costs caused by pandemic hardships, either because you had Covid-19 or because you lost income as a direct result of Covid-19. Early withdrawals used to buy securities would not count for the CARES Act exception, which some investors may have to learn the hard way.

Investor Beware: Early Withdrawals Can Jeopardize Retirement Plans

If you took an early withdrawal, securities attorneys advise that you spend that money as intended: On emergency expenses. This is not money that you can use to gamble, even on securities that supposedly have amazingly high returns.

Investors should always be wary of financial advisors who recommend withdrawing money from retirement accounts so they can buy high-risk, high-return securities. (Pro-tip: Anything that promises especially high returns is likely either high risk or highly fraudulent.) Retirement accounts are stable investments that come with compounding interest. Investors risk losing that interest when they put their retirement funds toward risky securities. Why risk your nest egg, especially at a time when our economic futures are still uncertain?

How Does the IRS Know an Individual Qualifies for an Early Retirement Withdrawal?

The IRS website specifies that individuals who want to take the penalty-free retirement withdrawal must meet the following qualifications:

  • You were diagnosed with Covid-19;
  • Your spouse was diagnosed with Covid-19;
  • You experienced adverse financial consequences as a result of being quarantined or laid off. You may also have had to work reduced hours because of the pandemic;
  • You could not work because you need to provide childcare because of Covid-19;
  • You experienced adverse financial consequences as a result of closing your business. Or, you reduced the number of hours your business is open because of Covid-19

What Kind of Proof Do I Provide Under the 2020 CARES Act?

The administrator of the retirement account simply needs the individual’s certification that they lost income because of Covid-19. According to the IRS, the administrator of a retirement account can rely on the individual’s certification that their withdrawal is for a Covid-19-related hardship – they are not required to have proof. That said, one CPA told Forbes that individuals should be prepared to provide proof that they lost income due to a Covid-19-related hardship. Additionally, the money investors withdraw from retirement accounts must cover necessities like home repair or medical expenses to meet the requirements of the CARES Act.

Keep in Mind Before You Withdraw from a 401(k)

The CAREs Act only offers so much flexibility. You must report the taxable portion of the distribution on your tax return. It’s possible to include the entire amount on your 2020 taxes or spread out the distribution over three years. Repayments reduce the amount owed on your taxes. You will not owe income tax if you pay back the amount borrowed within five years.

The SEC also warns that early withdrawals from a retirement account could have a compounding effect on the retiree’s investments. When investors liquidate a security in a retirement account at a time when the market is performing poorly, they must accept that loss. Left alone, the security may have time to potentially recover when the market improves.

What Can I Do Now?

If anyone advises you to take an early withdrawal, make sure you check out their credentials on BrokerCheck or the SEC’s Investment Adviser Public Disclosure database. Can’t find the broker you’re looking for by name? Ask for their CRD number. Anyone who cannot provide that number either is not registered to sell securities or may be attempting to hide a record of misconduct. In the event you believe your broker instructed you to make early retirement withdrawals in order to purchase high-risk securities, you should speak with a securities attorney. Contact the attorneys of Fitapelli Kurta for a free case consultation – call (877) 238-4175 or email info@fkesq.com.

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