Know This BEFORE You Pull Money from Retirement Accounts
The CARES Act (aka the Coronavirus Aid, Relief, and Economic Security Act) made it easier than ever to borrow or withdraw money from your retirement accounts before retirement age.
And even though most of the normal rules of personal finance have flown out the window during this crisis, the regular advice about retirement accounts still holds up: Leave that money where it is.
That said, if you have to choose between food, housing, medicine, and other absolute necessities or pulling money out of retirement accounts because you have no other options, doing that may be your best choice. (Please contact a financial advisor to help you work out the best plan and the right amount to take.)
If you’ve been affected by COVID-19, you’ll be able to access the money in your retirement accounts (whatever kind of retirement account you have), up to $100,000.
You can take out money from a 401k or IRA without facing the normal 10% tax penalty. You can borrow up to $100,000 from your 401k instead of the regular $50,000 cap. And now – at least temporarily – both of these options let you pay the money back.
Be aware that employers are NOT required to play by these rules. If your money is in an employer-sponsored retirement plan, you may not be able to access it at all.
Under the CARES Act:
- Even though you won’t have to pay early withdrawal penalties, you will have to pay income taxes on the amount you withdraw – at least 10% of the amount you take out. So if you take out $10,000, you’ll owe at least an extra $1,000 in federal income taxes alone. Luckily, the CARES act lets you pay those taxes in equal lumps over the next three tax years (2020, 2021, and 2022) if you can’t pay one big lump in 2020.
- If you take a withdrawal (as opposed to a loan) you can pay the money back within the next three years. If you do that, you’ll get any taxes you paid refunded.
- If you borrow money from your 401k, you can take 100% of your vested balance (the balance that you own entirely) up to $100,000 and you don’t have to start repaying that money for one year.
When you need money NOW, the money normally locked up in your retirement account may seem like your best option for quick cash.
But even with all of these CARES Act breaks, it’s still not a great idea. In fact, it could end up costing you thousands of dollars and putting you in an even worse financial position than you’re already in.
Here’s what you need to know before you pull any money out of any retirement account:
You’re going to lose money:Taking money out of retirement accounts means selling shares of whatever’s in your portfolio: stocks, bonds, mutual funds, etc. If you sell when the market prices are very low, you’ll be locking in those losses. You’ll have to sell more actual shares to get the same amount of money out than you would if prices were higher. And you’ll miss out on the financial recovery when it comes (and it will come).
Your retirement will probably suffer: Retirement accounts build up to much more than the money you put in because of long-term compounding (how your money grows on its own). Interrupting that process, especially during a down market, can make it impossible for your retirement account to recover and thrive.
401k loans can land you in financial peril: Borrowing money from your 401k comes with a pretty severe downside. If you leave your job for any reason – whether you get fired or laid off or you quit – you have to pay the loan back in full and fast. And that’s just one of the many ways 401k loans can come back to bite you. You can learn more about the drawbacks of 401k loans here.
Borrowing money is NOT an option with IRAs. That’s only available with employer-sponsored plans like 401ks and 403bs.
Try Something Else First
Before turning to your retirement accounts, tap every other resource you possibly can (other than predatory loans, like payday loans). You can find a bunch of other options, tips, and resources here.
If you’ve run out of other options, and you absolutely need that retirement money to get by right now, please talk with a trusted financial advisor about the best way to go about it.
And if you have any questions about how to manage your money during this financial crisis, please feel free to contact me.