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It’s been a tough year for most people, but there may be a silver lining—a clause in the CARES act that enables you to tap into your retirement savings with fewer restrictions and penalties. While it is an unconventional idea, at least some first-time buyers are using this provision to finally enter the housing market. If you think this may be an option for you, however, it is important to weigh all the pros and cons before proceeding.

Overcoming the Down Payment Obstacle

One of the biggest obstacles facing first-time buyers is coming up with a down payment. Nowhere is this truer than in New York City where housing prices are generally high and financing options are limited. In most markets, first-time buyers can tap into programs that permit high financing (sometimes up to 95 percent financing for first-time buyers). In New York City, such programs exist but generally can’t be used since virtually no co-op or condo permits 95 percent financing, and even 90 percent financing is now rare. While these measures are in place for a good reason, in New York City, even middle-class families are often left struggling to come up with a suitable down payment.

CARES Act Distributions

To be clear, there is nothing in the CARES Act that encourages people to withdraw retirement funds to make a major purchase. The ability to tap into your retirement funds at this time was a measure put in place to deal with emergencies (e.g., to pay your rent if you’ve lost your salary due to a furlough). That said, the CARES Act doesn’t explicitly prevent one from tapping into their retirement funds for other reasons.
To qualify for a CARES Act distribution you must meet at least one of the following criteria:

  • Have been diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention;



  • Have had your spouse or dependent diagnosed with SARS-CoV-2 or with COVID-19 by a test approved by the Centers for Disease Control and Prevention;



  • Have experienced adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced due to SARS-CoV-2 or COVID-19;



  • Have experienced adverse financial consequences as a result of being unable to work due to lack of child care due to SARS-CoV-2 or COVID-19;



  • Or otherwise have experienced adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to SARS-CoV-2 or COVID-19.

 

While eligibility requirements are clear, because many people were unable to get tested for COVID-19 early on, some retirement plans are not asking for evidence (e.g., a positive COVID-19 test result) to release funds. Likewise, some plans are not asking for evidence of lost income.

If you are eligible, there are several advantages to taking a CARES Act distribution from your retirement plan between now and December 30, 2020:
  • There is no obligation to pay back the loan

    Normally, if your retirement plan permits loans, you must repay the loan in full (usually within five years). Under the CARES Act there is no obligation to repay the distribution. The CARES Act only states, “you may repay all or part of the amount of a coronavirus-related distribution to an eligible retirement plan.” For this reason, lenders won’t treat the money as a loan, which is especially advantageous if you’re seeking financing.

    If you do repay your coronavirus-related distribution within three years, the distribution will be treated as a “direct trustee-to-trustee transfer” (said another way, you won’t be expected to pay federal income tax on the distribution). If you don’t pay back the distribution, that’s fine too, but you will be taxed at a rate of 20 percent (e.g., if your distribution is $60,000, you’ll owe $12,000 to the IRS but it can be paid back over three years).



  • You won’t pay a 10 percent penalty if you’re under 59 ½

    In most cases, if you’re under 59 ½ and take a distribution from your retirement fund, you must pay a 10 percent early withdrawal penalty. The CARES Act eliminates this penalty.



  • You can withdraw up to $100,000

    Finally, prior to the CARES Act, even retirement plans that permitted loans, generally capped the loans at $50,000; under the CARES Act, you can withdraw up to $100,000.

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(via Pexels)

What Potential Buyers Need to Know

First, most but not all employers have agreed to participate in this specific CARES Act provision, so you’ll need to confirm that your employer is participating. Second, if you choose to take out a large amount of money—for example, the maximum amount of $100,000—you will still pay on two levels:
  • Lost compounding interest: Nearly any financial advisor will tell you that it is always better to keep your money in your retirement fund than take it out. So, how much will you lose over thirty years if you take out $100,000 now? If markets continue to perform as they have over the past fifty years, the lost compounding interest will be significant. If you’re still in your forties and many years away from retirement, the lost compounding interest will add up to hundreds of thousands of dollars.



  • Tax penalties As already noted, under the CARES Act, you won’t be expected to pay the 10 percent penalty for early withdrawal, but you will be expected to pay a 20 percent tax on any money withdrawn. That means that if you take out $100,000, you’ll be expected to give $20,000 back to the IRS. Fortunately, you can spread the liability out over three years, and if you can pay back all or some of the withdrawn funds over the next three years, you’ll be able to reduce your liability accordingly.

Lost compounding interest and tax penalties aren’t the only things to consider before diving into your retirement savings to come up with a down payment.

  • Lenders are tightening their purse strings: So, you finally have $100,000 on hand to put down on a unit or, if you were already saving up before tapping into your retirement funds, much more. While this may be the first step toward securing a mortgage, be forewarned that since August, lenders have started to get nervous. Many lenders that were offering high financing options just a few months ago are no longer doing so. Likewise, lenders across the board are now looking for higher credit scores and longer and more stable credit histories. If you’re looking for 90% financing or have anything in your credit history that may raise a red flag, you may want to secure a potential lender prior to making a withdrawal.



  • Uncertainty in the real estate market: This could be a great time to buy, but no one knows for sure what will happen next. The real estate market could surge, decline, or hold steady over the coming years. Buying always comes with associated risks. Currently, buying comes with more risks and uncertainties than usual.

In the end, the decision to use the CARES Act to come up with a down payment could be the best or worst decision you’ll ever make. As a rule of thumb, New York City real estate does hold its value, even in a turbulent market. If you’re buying a unit that you plan to live in on a long-term basis (i.e., for more than a decade), the decision may be an unconventional yet wise one, despite all the contingencies currently at work.

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Contributing Writer Cait Etherington Cait Etherington has over twenty years of experience working as a journalist and communications consultant. Her articles and reviews have been published in newspapers and magazines across the United States and internationally. An experienced financial writer, Cait is committed to exposing the human side of stories about contemporary business, banking and workplace relations. She also enjoys writing about trends, lifestyles and real estate in New York City where she lives with her family in a cozy apartment on the twentieth floor of a Manhattan high rise.
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