If additional stimulus and/or unemployment funds don’t materialize over the next few months, it’s a good bet that more and more individuals and families will be looking for solutions to help pay their monthly bills. The CARES Act has provided leeway for anyone under 59 ½ who has been financially impacted by the coronavirus pandemic to pull money from their retirement funds penalty-free (as long as their plan is allowing coronavirus distributions).
Before you rush to take money out of your account, read the fine print. Any distribution pulled from a 401(k), a 403(b), or an IRA will be taxed as income, but those taxes can be paid over the course of 3 years — and if you repay the money over that time, you won’t be taxed. The CARES Act also upped the amount you can take as a loan from your 401(k), which is now $100,000 or 100% of your vested account, whichever is less.
In terms of a loan, “from now through September 22, 2020, you can borrow your entire balance up to that $100k, unless you already had an existing loan, in which case that will be counted against the total amount you can borrow. If you have to take a loan and already have an outstanding loan due before the end of this year, the new law allows you to delay repayment for up to a year (and this applies whether you’re still working or have been furloughed or on a temporary leave of absence, so long as you are qualified). Interest on the outstanding loan will continue to accrue, but with a 401(k) loan, you pay the interest to yourself,” explains Pam Krueger, Founder and CEO of Wealthramp, a referral service that connects consumers with vetted and qualified fee-only financial advisors.
Just because it’s available, though, doesn’t mean that you should empty the coffers. Although you may have already eliminated your other potential sources of cash, you don’t want to borrow or withdraw more than is necessary. Estimate the amount you need to cover expenses over the next six to nine months, CNBC advises. And note, because of the repayment provisions in the CARES Act, this is one time the distribution might be better than a loan.
“In “normal” times, people typically don’t have their cash reserves top of mind, but because the potential of being furloughed or laid off is more likely right now, there is a psychological urgency in needing to have more cash on hand,” Krueger says, highlighting why this is such a hot topic right now. “People feel more enticed to borrow, but it’s important to understand that borrowing should only be done when you cannot make ends meet any other way.”
In other words, don’t fall victim to the messages that the IRS may be sending — “Borrowing is being positioned as the best action to help Americans achieve some sense of financial relief and security during this economic environment, which can be a risky message for investors to internalize. It can prompt consumers to rob from their future selves. It is never a good reason to use your 401(k) as an emergency account,” Krueger adds.
Take the time to really consider the question: “Is this right for me?”
First, understand what pulling money from a retirement account means, and consider whether you will be able to pay it back within the five-year timeframe, Kreuger says. Take a look at your financial picture currently — do you actually need more money, or are you just taking advantage of what you see as a good opportunity? If it’s the latter, leave the money alone, at least until you truly need it to pay the bills.
If you’re tempted to take money, remember, “just because you can, doesn’t mean you should,” Kruger says. According to Deloitte, a typical 401(k) borrower who defaults on a 401(k) loan loses $300,000 of financial security at retirement because of taxes, penalties and foregone returns on their investment. “Those who take hardship withdrawals and don’t replace that money lose out on all the compounded tax deferred growth benefits they’d realize over the decades, which could easily be the biggest driver of their future wealth. Whether you withdraw or take out a loan, be strict with yourself and pay it back within the five-year deadline. Don’t take the money and run.”
Then, take a look at your other accounts. Ask: Is there another type of savings account I can dip into before my retirement account? Kreuger notes that a penalty to break your CD would be even cheaper than getting money out of your 401(k).
Finally, if you find that yes, you need cash, and yes, this is the best way to get it, taking a hardship loan is preferable to just making a withdrawal, Krueger says. She also recommends tapping into a Roth IRA before a 401(k) because you can withdraw money penalty-free if you’ve had the account for at least 5 years.
Once you take that loan, try to get out ahead of any stress you might incur by creating a plan to pay yourself back when you can. This will help to calm your nerves and will keep you accountable. Even if you’re not legally required to, getting the money back into your retirement accounts as soon as possible is of the utmost importance when it comes to borrowing.
MORE ON HERMONEY:
- I Have No Retirement Savings. Now What?
- How COVID-19 Is Changing Our Biggest Money Decisions
- The Biggest Financial Mistakes Women Make In Their 20s, 30s and 40s
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