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How to Decide on Using Retirement Savings Early

How to Decide on Using Retirement Savings Early
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By Friday, 02 October 2020 12:08 PM Current | Bio | Archive

With workers across the country feeling increased financial strains due to the economic impact of the COVID-19 pandemic, it’s natural to consider alternative sources for temporarily paying expenses, such as using retirement savings early.

This is becoming an especially important question in light of the Coronavirus Aid, Relief, and Economic Security (CARES) Act and its elimination of the early withdrawal penalty, currently through December 2020, which allows some people under the age of 59 ½ to use funds from their tax-deferred retirement accounts without penalty.

Is there ever a good reason to make an early withdrawal from your 401(k) or IRA? If you’re considering using your retirement savings to pay for your current expenses, here’s what you need to know.

Reasons to Consider Early Retirement Withdrawals

It might seem unconventional to take money from your retirement to pay for your current expenses, but it’s an option many Americans pursue each year. The Federal Reserve’s data shows 5% of non-retirees loaned themselves money from their retirement accounts in 2018, while 4% permanently withdrew funds and 1% relied on both methods to get the money they needed. Here are some reasons Americans are taking from their retirement accounts.

Pandemic-Related Financial Hardship

Americans who are facing economic hardship due to the COVID-19 pandemic can withdraw funds from their tax-deferred federal retirement plans penalty-free. For those who are facing the choice between paying for current expenses with a high interest credit card, losing their housing or taking out a high interest personal loan, withdrawing funds early from their retirement savings could be a savvy option.

The CARES Act allows a $100,000 per person penalty-free withdrawal in 2020, or a loan of the same amount if your employer allows.

Depending on your interest rate, loaning yourself money from your 401(k) could be the cheapest way to access funds right now. You’ll have three years to repay your loan, interest-free. Taking a withdrawal, rather than a loan, also keeps you away from high interest debt and could be a better last resort than facing homelessness or debt that will be difficult to repay.

Education

Many people feel like they’ll be trapped forever by student debt. In fact, 57% of Generation X and 55% of millennials feel they’ll be paying back student loans as long as they live. If you have a spouse, children or grandchildren who feel this way, it’s natural to want to find ways to help them with their educational expenses. Withdrawing from retirement savings is a common strategy. Higher education expenses can be withdrawn from an IRA penalty-free, even though you’ll have to pay taxes on the money you withdraw. You cannot use your 401(k) in the same way, and you will be subject to a 10% penalty on the funds if you withdraw them early, even if it’s to pay for education.

Remember, there are many federal student loan options available to students to help finance their education, but you can’t get a loan to pay for your retirement if you haven’t saved enough when you want to stop working.

General Financial Hardship

Many people who are facing financial hardship unrelated to the COVID-19 pandemic each year consider withdrawing from their retirement savings. If the financial hardship meets a certain IRS threshold to be considered “immediate and heavy financial need,” then there’s the possibility it could be withdrawn penalty-free.

Some other expenses can also qualify for penalty-free withdrawals. For example, up to $5,000 can be withdrawn penalty-free from a 401(k) to put toward adoption expenses. However, even when there is a penalty, many Americans still pursue this option as a last resort to pay for basic, emergency expenses such as housing and shelter.

Remember, if you’re experiencing financial hardship and having difficulty keeping up with your debt, there are many other options you can pursue before withdrawing from your retirement. For example, through refinancing your loan and choosing a longer term, you could lower your monthly payments, which could help you make room in your budget for additional expenses.

What to Consider Before Withdrawing

If you still think that withdrawing from your retirement is the right decision for you right now, here are some details to consider before doing so.

  • Penalties: Remember, unless your withdrawal qualifies for an exemption, you’ll have to pay a 10% penalty for early withdrawal. If you’re taking out $20,000 that means you’ll owe a $2,000 penalty.
  • Changes to income: You’ll need to report even penalty-free withdrawals as income, which could negatively impact you if you’re currently receiving unemployment benefits. Each state has different unemployment regulations, so check your state’s rules to see how this would impact you.
  • Tax burden: Withdrawing money from your retirement plan could mean you’ll be paying more income tax in the year you withdraw, although there could be ways to avoid some of this burden — for example, if you qualify for a COVID-19 loan and repay this amount within three years, you could receive a refund on taxes paid.
  • Market losses: If you’re cashing out your investments when the market is low, you’ll do so at a significant opportunity cost. Ideally, you’d want to wait for the market to correct before selling any investments.

Should You Use Your Retirement Savings Now?

Cashing out your retirement savings to pay for current expenses is never ideal, but sometimes it’s a necessary last resort for Americans who have no emergency savings and need to pay for basic expenses. Before you go this route, consider any other ways to earn income, reduce expenses or take advantage of community programs to get you through financial hardship.

If withdrawing from your retirement is the only option you have left, be careful to weigh the consequences before doing so.

Jolene Latimer has her master's in Specialized Journalism from the University of Southern California. She writes about personal finance, marketing and sports.

© 2020 Newsmax Finance. All rights reserved.


   
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With workers across the country feeling increased financial strains due to the economic impact of the COVID-19 pandemic, it's natural to consider alternative sources for temporarily paying expenses, such as using retirement savings early.
using, retirement savings, early, decide
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2020-08-02
Friday, 02 October 2020 12:08 PM
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