Coronavirus: Should I withdraw money from my 401(k)?

There’s a lot you need to know before digging into your retirement funds, and experts say it should be your last resort.

Many Americans are struggling financially because of the coronavirus. A recent federal relief package is making it easier for people financially harmed by the coronavirus outbreak to tap into their retirement savings for cash by easing withdrawal and lending rules.

But should they use them?

Experts say this is an option of last resort and should be done with great caution. A few things to consider first:

WITHDRAWALS

The CARES Act allows people financially affected by the coronavirus to withdraw up to $100,000 penalty-free from eligible retirement accounts in 2020. Previously, any withdrawal before age 59½ was subject to a penalty by 10%.

The new withdrawal rules apply to most retirement accounts, such as 401(k) accounts, 403(b) accounts, and IRAs. The rules are quite broad in terms of who is eligible: anyone who has been diagnosed with the virus or otherwise suffered related negative financial consequences.

People won’t face a penalty, but they will still have to pay taxes on the withdrawals. However, these tax payments can now be spread over three years.

If people repay what they have withdrawn over the next three years, those contributions will not count against the contribution limit.

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LOANS

Individuals can now take out a loan of up to $100,000, double the previous limit of $50,000, from qualified retirement accounts. People were also limited on what they could borrow – only up to 50% of the fully vested amount they held, now 100% of that is available.

Although retirement savings plans are not required to increase these limits, the legislation gives them the possibility to do so.

Anyone who has taken out a loan on their plan since the law passed on March 27 until the end of the year can also delay payments for a year.

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PROS AND CONS

It’s tempting for people in financial difficulty to turn to their retirement accounts for help at times like this. But experts urge people to consider all alternatives first.

Tax on withdrawals can be prohibitively expensive, even if spread out over time. And by selling holdings now, participants are withdrawing money at a low point in the market. They are also unlikely to refund it. Most importantly, it takes money away from them for when they need it – in retirement.

“(It’s) really, really the alternative of last resort. That’s where we go last,” said Evelyn Zohlen, president of the Financial Planners Association. “It’s sacrificing your future financial security for your current financial security.”

Boston College’s Center for Retirement Research estimates that about half of today’s working families — before the crisis — would not have been able to maintain their standard of living in retirement. This is partly because people are withdrawing money from their retirement account early. Alicia Munnell, director of the center, said their best estimate is that around 1.5% of assets leak each year.

“It may not seem like much, but it means retirement assets are 20% lower than they would have been without the leak,” Munnell said.

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ALTERNATIVES

Experts urge people to consider other sources of money first.

If you have an emergency savings account, now is the time to use it, said Eliza Badeau, director of Thought Leadership at Fidelity Investments. The next line of defense is money held somewhere not exposed to the stock market, like a CD. Then consider other non-retirement accounts that have exposure to the stock market — such as a brokerage account, vested restricted stock, or stock purchased through an employee stock purchase plan.

If your situation is temporary, consider using a credit card with no balance to pay for the essentials. Only do this if you can pay the balance within the month. A personal loan or home equity loan is another option, only if your situation is temporary and the rates are favorable.

Also, be sure to reduce the money spent on your household as much as possible. This means taking advantage of relief programs, such as those for student loan repayments, late income tax payments or more.

If you still need to dip into your retirement savings, consider a loan first rather than a withdrawal. A borrower does not face the same tax consequences and the impact on your future financial situation is mitigated, as borrowers are obligated to repay the loan.

However, if you leave your employer, by choice or not, the loans must be repaid soon after.

Take only what you need to minimize the impact, but take enough to support yourself, as plans generally limit the number of loans or withdrawals people can make.

If you take money out of your retirement account, make sure you have a plan to pay taxes and pay off the account, said Michael Foguth, of Fuguth Financial Group in Michigan.

“It’s not necessarily a bad idea, if done correctly,” Foguth said. “Given the circumstances, you have to do what you have to do.”

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