Unemployment, a cut in hours and job insecurity have created financial stress for many families. To make ends meet, some people have considered taking an early withdrawal from their retirement plans. While this is an option, it might not be the best option.
Here’s what you should know:
Your retirement savings accounts are set up to be off-limits to withdrawals until your retirement. The IRS has restrictions and hefty penalties in place to discourage you from taking funds out of your retirement savings unless it’s a last resort. But for many who have permanently or temporarily lost their jobs as a result of the global Coronavirus pandemic, whose expenses keep coming while their income has dropped, this may seem like a last resort if there ever was one.
The Coronavirus Aid, Relief and Economic Security (CARES) Act temporarily allows qualifying Americans to withdrawal up to $100,000 from eligible retirement savings accounts, including 401(k)s and IRAs, without the standard 10 percent penalty for withdrawals made before you reach age 59-½. The dates of qualifying distributions must be between March 27 and December 31, 2020.
To qualify, you or your spouse must have been diagnosed with COVID-19 or financially impacted by it.
If you’ve been laid-off or furloughed from your job, you may be more tempted than ever to tap into your retirement funds to cover your rent or mortgage payments, monthly bills and everyday expenses. You should truly exhaust all of your other financial options before dipping into your retirement savings accounts, because taking money now, even free of penalties, can have major negative long-term impacts on your retirement plans.
The deposit-only mentality for retirement plans is meant to protect your savings, as well as your ability to contribute to and grow your savings during your working years. If you treat your 401(k) like a regular savings account, your balance may not be where you need it to be when you retire.
A low point in the market is actually the worst possible time to take money from investment accounts – that because the current value of an investment is lower, you’ll have to take a bigger chunk out in order to withdraw the amount you need.
Also, investment growth potential is actually strongest during a low point in the market: Buying 10 shares of a stock at $15 each costs $150, but if you bought those same 10 shares at $9 each, you’d still have purchased the same 10 shares, but at a savings of $60. (Read our recent blog post: Why Investing at Low Prices Can Be a Good Thing.)
By taking a withdrawal from your retirement accounts now, you not only put a dent in your current plan balance, but you also reduce your ability to exponentially grow your future balance. A $50,000 withdrawal now could have been worth almost $138,000 in 15 years, at a rate of 7 percent interest, compounded annually.
Another thing to remember is that while the CARES Act absolves you of the 10 percent early-withdrawal penalty, you’ll still have to pay income taxes on distributions. Thanks to the CARES Act, you will be able to spread the tax burden from qualifying distributions over the next three years of tax returns, but it will still have to be paid.
Financial planning is complex. Making short-term decisions now can hurt you in the long-run. Contact Rock House Financial and see how we can help.
Ask for Help
Before you do anything else, contact your creditors to inform them of your hardship. Lots of people are in the same situation, and many banks and lenders are offering deferment and forgiveness options you might be able to take advantage of to get you through the leanest months. If you can put some or most of your payments on hold until you get back to work, you might not need to take money from a backup source after all.
(For example, for assistance with student loan debt, read our recent blog post: Federal Student Loan Payments Suspended in Wake of Coronavirus Pandemic.)
If you do need help covering expenses, look to any savings you have first. This is precisely the type of emergency an emergency fund is established for. Try not to take it all out at once though. Just transfer what you need as you need it. And be sure to start replenishing the balance when you get back to a regular income.
The recommended emergency fund is the equivalent of three to six months’ worth of expenses.
Because property values are on the rise and interest rates are on the decline, now might be a good time to borrow against the equity you have in your home. You might be able to get a home-equity loan or line of credit at a low rate to help with expenses until you get back on your feet.
However, these types of loans are not for everyone. Read our recent blog post: Is Refinancing in Today’s Climate a Good Idea?
Interest rates for personal loans are likely to be higher than home-equity loans but lower than credit card interest rates. These are typically used for debt consolidation, vehicle purchases and home improvements, but a personal loan may be a good option to help financially get you through a rough patch.
Discuss your situation, your concerns and your goals with a financial advisor to determine the best options for you.
A 401(k) Loan
If none of these other options are available and you must tap into your retirement funds, talk with a financial advisor about how to do it. You have options, such as taking a loan against the balance in your 401(k) account. A loan can be better than a withdrawal because you’re not subject to the income tax liability as long as you make installment payments and pay off the loan in a designated time. You’ll have to pay the loan back with interest, but you’re paying the interest to yourself.
The CARES Act also allows you to delay repayments for up to one year.
Again, financial planning is not a one-size-fits-all solution and these loans are not right for everyone, so make sure to discuss your options with a financial advisor you trust.
The Bottom Line
Unless you absolutely have to, you don’t want to take money out of your retirement savings. Just because the CARES Act has made it possible to dip into your retirement funds doesn’t mean you necessarily should. Likewise, you probably shouldn’t take the full amount allowed, $100,000, unless you really, truly need it. If you take more than you need, you may be tempted to use funds unwisely.
If you need help weighing your options or deciding how to weather this financial storm, have a conversation with a financial advisor and get advice you can trust. You can also talk to your employer, union and/or plan administrator to see what, if any, help may be available for you.
If you’re looking for a financial advisor in Utah, contact Rock House Financial. We are a fee-only fiduciary financial advisory firm that has been helping busy families with their financial planning needs since 2007.