What Were the CARES Act Hardship Withdrawal Rules?

The Coronavirus Aid, Relief, and Economic Security (CARES) Act was enacted in March 2020 to address the economic fallout from the COVID-19 pandemic. A component of this law involved temporary changes to the rules governing retirement plan distributions, designed to provide individuals with faster access to their savings and offer financial flexibility.

These rules were a temporary measure for the year 2020, and the relaxed withdrawal standards and favorable tax treatments have since expired. Understanding these past rules is helpful for individuals who took such a distribution and are still navigating its tax implications, or for those seeking to understand the government’s economic response.

Defining a Qualified Individual

To access retirement funds under the CARES Act provisions, an individual had to meet specific criteria to be defined as a “qualified individual.” This designation was contingent on experiencing direct impacts from the coronavirus pandemic to ensure the relief was targeted to those affected by the public health emergency.

An individual was eligible if they, their spouse, or a dependent were diagnosed with SARS-CoV-2 or COVID-19 by a test approved by the Centers for Disease Control and Prevention. The law also extended eligibility to those who suffered adverse financial consequences from the pandemic.

Beyond a direct diagnosis, a person could qualify by certifying they experienced adverse financial consequences. These consequences included being quarantined, furloughed, laid off, or having work hours reduced. Eligibility also extended to individuals unable to work because of a lack of childcare or those who had to close or reduce the hours of a business they owned or operated. Plan administrators could rely on an individual’s self-certification that they met one of these conditions.

Characteristics of the Distribution

The CARES Act established distinct rules for “coronavirus-related distributions” (CRDs), setting them apart from typical hardship withdrawals. These provisions addressed the amount that could be withdrawn, the types of accounts it could be taken from, and relief from common penalties and tax withholdings.

A qualified individual could withdraw up to $100,000 in aggregate from all their eligible retirement plans during 2020. This was a per-person limit, not a per-account limit. This rule applied to retirement accounts including 401(k)s, 403(b)s, governmental 457(b) plans, and traditional IRAs.

One of the benefits was the waiver of the 10% early withdrawal penalty. Normally, distributions taken before an individual reaches age 59½ are subject to this additional tax. The CARES Act suspended this penalty for CRDs.

The law also waived the mandatory 20% federal income tax withholding that applies to hardship distributions from employer-sponsored plans like 401(k)s. While income tax would still be due on the distribution, this change ensured that individuals received the full amount of their requested withdrawal upfront.

Tax Reporting and Repayment Rules

The CARES Act provided post-withdrawal options for managing the tax impact of a coronavirus-related distribution, offering flexibility that extended beyond 2020. These rules centered on how the income was reported to the IRS and provided a window for individuals to restore their retirement savings.

A provision allowed individuals to spread the income tax liability over a three-year period. Instead of recognizing the entire distribution as income in 2020, a person could elect to include one-third of the amount on their federal income tax returns for 2020, 2021, and 2022. This spreading of the tax burden could prevent the distribution from pushing the taxpayer into a higher tax bracket in a single year.

The law also permitted individuals to repay all or part of their CRD to an eligible retirement plan. This repayment could be made at any time within a three-year period beginning on the day after the distribution was received. These repayments were treated as a tax-free rollover and were not subject to annual contribution limits.

If an individual had already paid income tax on a distribution that they later repaid, they could file an amended tax return for the year the tax was paid to claim a refund. For example, if someone included one-third of their distribution in their 2020 income and then repaid the full amount in 2022, they could file an amended 2020 return. All tax reporting and repayment options were managed using IRS Form 8915-E.