In a recent Wall Street Journal article, they talked about people tapping retirement funds during the current financial crisis. We have some thoughts on the subject. Retirement planning is hard enough as it is. During a crisis, such as COVID-19, it’s even harder. This is especially true if you have been impacted financially. But there are some keys to keep you on track and tapping retirement funds may be a solution for you.
As everyone is well aware, planning for retirement is essential for your future. It goes without saying that the earlier you start, the better off you will be. Under normal circumstances, tapping retirement funds should be a last resort. Obviously, these are not normal circumstances. However, withdrawing those funds during a crisis should be done only if it’s absolutely necessary. The power of tax-deferred gains and compounding interest is what makes retirement plans so good. The more money you have in there, the more faster it can grow.
Withdrawing funds from the plan and not returning them is known as leakage. Again, during normal times, once you take out the money, you cannot replace it. You may continue to contribute up to the annual limit, but you can’t exceed them, ever. Thanks to the CARES Act, there is some leniency for retirement plan withdrawals and loans. More on this later.
This is why the IRS sets rules for retirement plans. There are taxes and penalties to pay if you use retirement funds before you actually reach retirement age. If you are under age 59 1/2, you pay a 10% penalty on any amount you distribute from your traditional 401(k) or IRA. This encourages all Americans to earmark those funds for retirement.
Tapping Retirement Funds Now
Obviously, Americans across the country are suffering, both physically and financially. The CARES Act provided trillions of dollars to the American people. However, this may not be enough. In the Act, there are also provisions allowing easier access to your retirement funds. These include:
- $100,000 penalty-free distribution from your IRA or 401(k)
- The ability to pay the taxes over three years or re-contribute those funds within three years to avoid taxes
- Up to $100,000 via a 401(k) loan with no repayments for one year
- No RMDs for 2020
Therefore, the government is allowing to use your retirement funds to help get through this crisis due to the COVID-19 virus. But should you? According to the WSJ article, more and more people think it’s a necessary decision. We agree, within reason of course. Since it is our goal at IRA Financial to help people save for retirement.
Desperate times call for desperate measures. What good is it to sock everything away for retirement if you are facing economic disasters right now. Many small business owners may never recover from this crisis. Families need to put food on the table and keep a roof over their heads. If you need that money to survive, by all means, grab as much as you need. However, don’t go overboard and take everything out. The more you take, the longer you need to recover. You can always withdrawn more if you need it later in the year.
Best Way to Tap Your Retirement Funds
If you are looking at tapping your retirement funds, it’s important to consider your options. If you have a 401(k) plan loan option, that’s generally the best way to dip into your savings. You are required to pay the plan back and all interest owed on the loan is also returned to the plan. However, that option is not available to everyone.
Next, is to consider a Roth IRA if you have one. All contributions made to the plan can be withdrawn at anytime without penalty or taxes. It’s important to note that any earnings are taxable and subject to penalties if withdrawn early. The funds can be used for any reason and do not get returned to the plan.
Traditional IRA withdrawals are subject to tax and penalties. As we mentioned, the penalties are waived during this crisis. Further, any distribution can be returned to the plan if you become financially solvent in the next three years. You are not allowed to borrow funds from your IRA. However, since you can re-contribute the funds you withdraw, this is akin to taking out a loan, that’s payable over three years.
Should You Do It?
Only you can answer that question. You must first realize the ramifications of tapping retirement funds early. All funds withdrawn lose their tax advantages and weakens the power your retirement plan has. The longer the account goes without these funds, the worse it will be in the end. Of course, if you are younger, you have time to recover. Older people do not have the luxury of time on their side. As with any type of economic slowdown, the country and the economy will rebound. Of course, these are unprecedented times and no one can say for sure how long this will take.
You should seek out all means of help the government has offered the country. This may be loans offered by the SBA for small business owners, unemployment benefits and stimulus checks. If you are still coming up short, it may be time to dip into your savings. Only take as much as you need and try to put it back in as life allows.
It will be imperative to ramp up your savings when the crisis has passed, which it will. Of this, we have no doubt. However, it’s also important to be smart in all aspects of your life right now. Do everything in your power to keep you and your family healthy and financially stable. If this means tapping your retirement funds, by all means, do what you need to! Good luck and be healthy friends.