The CARES Act makes it easier for Americans struggling with economic hardship from the coronavirus pandemic to withdraw money from their retirement accounts.
Should you take advantage of it? Experts typically advise against it, but the fallout from the crisis has left many people scrambling to pay their bills after being laid off or furloughed.
The new provisions from the CARES Act allow Americans to draw down money from tax-deferred accounts without penalties. It also relaxes rules on taking out a loan from a 401(k) savings plan.
But there are factors to consider before rushing to tap into your retirement funds. Evaluate your short-term financial needs and potential tax implications when considering whether to withdraw money from your nest egg.
“People work hard for their retirement savings and you should dip into that as a last resort,” says Charlie Nelson, CEO of retirement and employee benefits at Voya Financial. “Americans need to think long and hard about other sources of savings first before withdrawing money from retirement funds.”
Should I withdraw money from my 401(k)?
Marc Walstedter of Danbury, Connecticut found out last month that he had been let go from his job. The 47-year-old was a sales director at Auction Simplified, a firm that provides software programs for auto dealers. The company came under financial pressure after auto dealerships shuttered due to the virus outbreak.
Now he’s worried about how he’s going to make his monthly $2,300 mortgage payment.
“Unemployment isn’t going to cover my mortgage payment,” Walstedter says. “My wife and I have already talked about dipping into our 401(k)s so that we can get by with our two kids.”
Experts advise taking a look at your expenses to identify where you can cut costs if you're facing unemployment.
To be sure, pulling funds from retirement accounts out of fear isn’t the best immediate course of action, wealth advisors say. It’s a case-by-case basis. Do you have emergency savings? Are there opportunities to refinance student loan debt, mortgage or car payments? Investors should take advantage of lower rates first before they tap into their retirement funds, experts say.
“Once you pull funds out of your retirement accounts, it could take a while to replenish and it could be quite detrimental to long term savings goals,” says Tim Bray, senior portfolio manager at GuideStone Capital Management. “People should cut expenses and take advantage of the emergency checks coming from the government’s stimulus package before withdrawing money from their 401(k)s.”
How does a 401(k) withdrawal work?
A 401(k) plan is a retirement option offered by employers, which gives employees a tax break on money set aside for their golden years. Depending on the employer's 401(k) plan, contributions made to retirement savings could be matched by employer contributions. Typically, employers match a percentage of an employee’s contributions, up to a certain portion of their salary.
One provision from The CARES Act allows investors of any age to withdraw as much as $100,000 from retirement accounts including 401(k) plans and individual retirement accounts this year without paying an early withdrawal penalty of 10%. They can avoid taxes on the withdrawal if the money is put back in the account within three years. If it isn't returned, taxes can be paid over a three year span.
Should I take out a loan from my 401(k)?
Under the CARES Act, you can take out a 401(k) loan for up to $100,000, or if lower 100% of the vested account balance for the next six months. That’s up from a prior limit of $50,000, or if lower 50%. Individual retirement accounts don’t allow loans.
Typically, you have up to five years to repay a 401(k) loan. Now the new provision gives Americans an additional year to pay back the loan, raising the time period to six years. Outstanding loans due between March 27 and Dec. 31 will also be extended by a year.
Experts say you could consider taking out a loan to tide you over if you’ve been furloughed, but are confident that you’ll be working again in the near future. A 401(k) withdrawal would make more sense for someone who has been laid off and doesn’t have a safety net or enough saved for basic expenses over the next three to six months, they said.
To be sure, if you lose your job, you could be on the hook for taxes for the amount borrowed for a loan.
The loan and withdrawal changes may provide current and future retirees more flexibility, but individuals need to understand the potential long-term financial consequences, experts say.
“You want to access your immediate savings first before you take out a loan or withdrawal from your 401(k),” says John Carter, president and chief operating officer at Nationwide Financial. “History tells us that when markets rebound after a downturn, it typically happens fast. Tapping into your retirement funds may prevent you from benefiting over the long haul if you take out loans and stay out of the market.”
Does my employer offer these provisions?
The provisions aren't automatic. The CARES Act loan and distribution provisions require employers to adopt those rules, according to Nelson. So you need to ask whether your employer offers these provisions in your 401(k) plan.
About 75% to 85% existing 401(k) workplace plans currently offer some type of hardship or loan provision, Nelson says.
Depending on your needs, you still have options even if your employer doesn’t include the new provisions. Prior rules allow Americans to take out a 401(k) loan of up to 50% of their vested account balance, or a maximum of $50,000.
To qualify for the retirement distributions or loan provisions, you must have suffered a financial hardship from the pandemic. That includes being diagnosed with Covid-19; subject to quarantine; a business closure or reduce your hours; inability to work due to child-care issues; or if you're not self employed and were laid off or had hours reduced.