Millions of Americans are struggling financially because of COVID-19. To provide relief, lawmakers passed the CARES (Coronavirus Aid, Relief, and Economic Security) Act in late March, which comes with a number of provisions designed to help those impacted by the ongoing crisis. Those provisions include one-time stimulus payments, boosts in unemployment benefits, small business funding, and more flexibility with tax-advantaged retirement savings plans.

Specifically, anyone with an IRA or 401(k) who's been affected by COVID-19 can now withdraw up to $100,000 penalty-free, regardless of age. Normally, you're hit with a 10% early withdrawal penalty if you remove funds from either account prior to age 59 1/2 (though there are some exceptions). Furthermore, the CARES Act has raised 401(k) loan limits from $50,000, or up to 50% of your vested account balance, to $100,000, or 100% of your vested account balance.

Envelope labeled 401k with cash sticking out of it on a wooden surface next to a pen, calculator, and pair of eyeglasses


In other words, if you have $100,000 sitting in your 401(k), you can withdraw that full amount right now in loan form. If you only have $75,000 in your 401(k), you can't borrow an extra $25,000 you don't have, but you can take out that full $75,000 as a loan.

Under normal circumstances, taking out a 401(k) loan is generally preferable to taking an early withdrawal. That way, you wind up paying yourself back so that the amount you remove from your retirement plan is eventually restored, thereby helping you avoid a potential shortfall as a senior. But because of the way the CARES Act works, it could actually be more beneficial to take an early 401(k) withdrawal rather than opt for a loan.

Why withdraw versus borrow?

The main reason why it now makes sense to take an early 401(k) withdrawal rather than a loan is this: If you don't pay your loan back on time, it'll be treated as an early withdrawal that's subject to the 10% penalty that normally applies.

Now you may have every intention of taking out a 401(k) loan and paying it back, but if your financial circumstances change for the worse, and you're suddenly unable to repay it, that loan won't be converted to a penalty-free early withdrawal. Rather, you'll incur that penalty for a regular old early withdrawal, which could be quite costly depending on the amount you borrow.

That's why right now, an early 401(k) withdrawal could actually make more sense. That way, you know you're protected against that penalty.

That said, if you're going to go that route, it pays to take an early withdrawal but treat it as a loan -- meaning, aim to put that money back into your 401(k) when you can. Doing so will help ensure that you don't fall dangerously short on money once you're retired and you need to start tapping that 401(k) regularly to pay your living expenses. Granted, if you're desperate for money now, it may take some time for you to replenish your retirement plan. But if you take an early withdrawal rather than a loan, but treat it as a loan, you can repay it on your own terms, thereby eliminating some stress during an already trying period.