In March 2020, the CARES Act threw out financial lifelines for those affected by COVID-19. One of those lifelines loosened the normal restrictions on 401(k) withdrawals. The program gave financially strapped retirement savers a quick means of raising cash to keep their bills paid. But now, months later, coronavirus-related distributions have turned out to be vastly more expensive than anyone would have predicted.  

Since the market crashed in March, share prices have shown exceptional strength. As you can see in the chart below, the S&P 500 grew some 46% between April 1 and Nov. 30 of this year.

^SPX Chart

^SPX data by YCharts

That's great news for retirement savers who kept their money invested throughout the year. Unfortunately, it's not great news for anyone who took a coronavirus-related distribution earlier in 2020.

Depending on how your retirement funds were invested, your balance may or may not have been growing in lockstep with the market. But if you were seeing market-level growth in your retirement account and you'd taken the maximum $100,000 distribution in early April, that withdrawal may have cost you as much as $46,000 in lost earnings.

That's a tough number to accept, but it doesn't mean your retirement plan is dead in the water. If you're back on your feet today, take these three steps to minimize the damage and get your retirement plan back on course.

Upset woman holding her hand on her forehead.

Image source: Getty Images.

1. Plan to repay the funds before 2023

Normally, an early withdrawal from your retirement plan incurs both income taxes and penalties. In 2020, the CARES Act waived penalties for coronavirus-related distributions and also extended the timeline for paying the income taxes. Instead of paying your taxes on the withdrawal by Tax Day of the following year, you can spread out the tax liability over three years. Technically speaking, you'd recognize one-third of your distribution as income in each of your next three tax returns.

But here's the kicker. If you repay the withdrawal in full before the end of 2022, you get credited back all of the federal taxes you've paid on that distribution. Depending on your tax rate, that could save you $15,000 or $20,000 on a $100,000 distribution. To get your credit, you'd have to file amended tax returns for 2020 and 2021 once you repay the funds.

Check with your 401(k) plan administrator on the process for repayment. Know that you can't do it by increasing your paycheck deferrals, since the funds have to come from you. According to the IRS, your plan should treat the repayment as a rollover contribution.

2. Increase your contributions

While you're saving up the money to repay your distribution, you should also increase your regular retirement contributions if you can. Saving more is the only way to make up for those lost gains.

You might have to redo your budget and streamline your expenses to find the extra funds. It's worth the effort to do this now, rather than later. Money invested today is your most powerful weapon when it comes to building momentum in your long-term savings plan. That's because what you invest today has longer to grow than funds invested next month or next year.

3. Create an emergency fund

Lastly, make a plan to build an emergency cash fund. This will be the pot of money you can reach into next time instead of your retirement account. Advisors generally recommend you target an emergency fund balance that covers three to six months of your living expenses. If that amount seems unachievable, shoot for enough to pay your highest insurance deductible and one month of your rent or mortgage payment. Once you reach that goal, reassess and set a new target.

Close the door on 2020

You took a lifeline from your retirement plan and the stock market rallied in the months since. It's a crummy situation, for sure. But it's also water under the bridge, as they say. Don't get hung up on what could have been. Instead, chart a course for improved financial strength in 2021 and beyond.