Millions of Americans have been hit hard financially due to the coronavirus pandemic, and the months ahead look grim as the number of COVID-19 cases continues to surge. Although Congress has not yet reached an agreement about another stimulus package, many benefits under the CARES Act are still in effect.

However, those benefits are set to expire on Dec. 31, 2020. And there's one key retirement money loophole you might consider taking advantage of before it disappears.

Young man holding hundred dollar bills in front of his face

Image source: Getty Images.

Retirement benefits under the CARES Act

The CARES Act, which was passed in March of this year, includes several provisions aimed to provide financial relief to U.S. households. One of those benefits is the ability to withdraw money from your 401(k), 403(b), or IRA without facing penalties.

Typically, taking money from one of these accounts if you're under age 59 1/2 results in a 10% penalty and income taxes on the withdrawal amount. Under the CARES Act, though, you can take penalty-free withdrawals of up to $100,000. The only caveat is that, to be eligible for these distributions, you'll need to be experiencing coronavirus-related financial hardship.

In addition, withdrawing funds now can reduce your tax burden. Before the CARES Act, you would be subject to income taxes immediately after making your withdrawal. Now, although you'll still owe income taxes on your penalty-free distributions, you can pay them over three years.

If you expect to be able to repay your withdrawal, the CARES Act also allows you to redeposit your distribution into your retirement fund within three years without owing taxes. Repaying your distribution quickly will not only help you avoid the penalty and income taxes, but it can also reduce the withdrawal's impact on your long-term savings.

These benefits are going to expire at the end of the year. So if you're planning on making a hardship withdrawal, doing it now rather than waiting until 2021 could save you some money.

The dangers of early distributions

Although these provisions under the CARES Act make it more affordable to withdraw from your retirement fund, there are still plenty of risks involved with taking early distributions. For one, you'll likely still have to pay taxes. Spreading your payments out over three years can make each payment more affordable, but if you withdraw a significant amount of money, that's still a hefty tax bill.

More importantly, taking early distributions can hurt your long-term savings. Every time you take money from your retirement fund -- even if it's only a few hundred or thousand dollars -- you're reducing your investments' earning potential.

Say, for instance, you have $100,000 in your 401(k) and you withdraw $5,000 right now. Here's what your savings would look like over time if you were earning average stock market returns and didn't make any additional contributions:

Number of Years Total Savings Without Taking a Distribution Total Savings After Taking a Distribution
0 (Today) $100,000 $95,000
10 $216,000 $206,000
20 $466,000 $433,000
30 $1,006,000 $956,000

Data source: Author's calculations, using an 8% average annual return. Numbers rounded to the nearest thousand.

Although a $5,000 withdrawal may not seem like much, it can potentially amount to around $50,000 in missed investment gains over 30 years. So before you take an early distribution, consider how that withdrawal will affect your long-term savings.

Should you make a withdrawal now?

Whether or not to raid your retirement savings is a highly personal decision and will depend on your unique situation. If it's a true emergency and you have no other savings, tapping your retirement fund might be your only option. And if you already know you're going to make a withdrawal, doing it before the end of the year is a smart move -- especially if you think you might be able to pay it back within the next three years.

If at all possible, though, aim to avoid taking early distributions from your retirement fund. Try your best to set aside cash in an emergency fund for the future, so you won't need to touch your retirement savings when money is tight. No matter what you decide to do, make sure you've thought about all your options and weighed the risks and rewards.