The pandemic has had a negative effect on the finances of many American families. It has left them with no other source of income and that means many people are tapping their 401(k) plan as a last resort.

Typically, if you withdraw funds from your 401(k) account before reaching age 59½, you’ll be charged income taxes on the withdrawal, as well as a 10% early withdrawal penalty. The CARES Act has made it easier for workers suffering due to the Covid-19 pandemic to tap their 401(k) plans and IRAs.

While the CARES Act waives the early withdrawal penalty, there are still tax consequences on the amount you withdraw. That’s why it's essential to understand how the 401(k) distribution works.

The amount of money you take from your 401(k) will be added to the rest of your income for 2020 and your total income will determine your tax rate for the year. However, the taxes you owe as a result of the 401(k) withdrawal can be paid over three years.

Basically, the CARES Act distributes the tax burden over a period of up to three tax years, unless you choose not to, and lets you re-contribute some or all the funds that you withdrew by the third year and then you must file amended tax returns after replenishing your 401(k) plan.

If you are interested in exploring these options, you need to fully realize the income tax consequences of taking the distribution. It’s also key to start thinking about how you’re going to foot the future tax bill.

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