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If you’re among the millions of Americans struggling financially as a result of the COVID-19 pandemic, you may be able to find the relief you need with your 401(k) or IRA. The recently enacted CARES Act has temporarily loosened withdrawal restrictions to allow people who have been financially harmed by the economic shutdown to tap their retirement plans.
But is that a wise move?
While it may seem like a viable option, most experts say it should be an option of last resort, especially during a declining stock market.
Here’s what you should know about taking money from your retirement plan under these circumstances.
Taking a Withdrawal
Typically, if you want to make a withdrawal from your 401(k), 403(b), or IRA plan before age 59 ½, you would incur a 10% penalty on top of the ordinary income taxes you pay. Under the CARES Act, anyone who is diagnosed with COVID-19 or who suffers a financial hardship is allowed to withdraw up to $100,000 without penalty during 2020.
While you won’t incur a 10% penalty, you will still have to pay taxes on the withdrawals. However, you are allowed to spread those tax payments over the next three years. If you repay what you withdraw over the next three years, you pay no taxes.
If you have a Roth IRA, you are golden because withdrawals taken five years after opening the account are neither taxed nor penalized.
Taking a Loan
Alternatively, you can borrow up to $100,000 or 100% of your account value from employer-sponsored qualified retirement accounts. That’s double the $50,000 and 50% cap under normal circumstances.
For loans taken between March 27 and December 31, 2020, payments may be delayed for a year.
Not all employers allow loans on their 401(k) plans and, while they have the flexibility under the CARES Act to increase the borrowing limits on their plans, employers are not required to do so.
Things to Consider Before Taking a Withdrawal or Loan
While it may seem tempting to tap your retirement accounts to bridge you through this challenging time, you should also consider all alternatives.
Any withdrawals taken will be taxed at your ordinary income tax rates - both federal and state. Even if the taxes are paid over a three-year period, it could be difficult to come up with that money, especially if you take the withdrawal in a declining stock market. Repaying a loan could also be challenging under these circumstances. In essence, you are potentially trading your future financial security for your present financial security.
If you have to resort to a withdrawal or a loan from your retirement account, it would be essential to develop a plan for repaying it. You should also make contingencies in your retirement plan in the event you are unable to repay your retirement account.
If you have cash alternatives – such as CDs or a money market account, you should choose those before tapping your retirement account. Other options could include a brokerage account or vested restricted stock from an employee stock purchase plan.
With today’s low-interest rates, you could consider a home equity loan or personal loan as a source of cash. If you anticipate a short-term need for money, you could consider using a credit card to pay for budgeted monthly expenses, but only if you can pay the balance in full each month.
Regardless of the option you choose, you should take a hard look at your budget and reduce non-essential expenses wherever you can.