401(k) plans are the bedrock of retirement planning and allow you to deduct savings from your salary while deferring taxes until you make a withdrawal. Previously, an individual had to wait until they reached retirement age (59.5 years old) to access 401(k) money or be hit with an early withdrawal fee. However, due to the COVID-19 pandemic, the United States Congress has eliminated these fees by passing the CARES act. This legislation, combined with a wild rollercoaster of the economic market where many citizens have lost thousands from their retirement plans, has forced countless Americans to ask, “Should I take money out of my 401(k) right now?” While it may appear to be the best time to take out money from your retirement account, we will look at several implications you should consider before making this critical decision.

What Does the CARES Act Say About Retirement Funds?

Specifically, under section 2013, the CARES Act states that a “plan shall not be treated as violating any requirement of the Internal Revenue Code of 1986 merely because the plan treats such distribution as a coronavirus-related distribution.” The Internal Revenue Code of 1986 refers to Title 26, which outlines the rules and regulations of federal taxation in the US. What this means is that the laws governing the 20% tax withholding and 10% early-withdrawal fees have been suspended for eligible retirement plans and individuals. Note that there is a limit of $100,000 that can be withdrawn in this manner. Additionally, if you do pull money out now, the amount of the distribution may be repaid any time during the three-year period beginning on the date the delivery was made.

Special Rules Related to Tax-Free Distributions

Included in the language of the CARES Act are a few special rules. For example, coronavirus-related distributions are not treated as eligible rollover distributions, which is directly related to distributions or transfers from trustee to trustee.

Who is Eligible for a Coronavirus Related Distribution?

Congress included definitions of who is eligible to withdraw funds from their retirement plans. These include individuals directly infected with the coronavirus, individuals whose spouse or dependent has been infected, or anyone who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, unable to work due to lack of child care, or who has been forced to close or reduce the hours of their business. This description covers a large swath of the American population, allowing affected individuals to make a withdraw from their retirement plan without penalty. So once you know you are eligible and can take money out of your policy under the new rules, the natural question arises: “SHOULD I take money out of my 401(k)?” Let us investigate that question further.

Should You Withdraw Money from Your 401(k)?

Now that we have a firm footing on what is currently happening with retirement plans in the US, back to the matter at hand: should you withdraw money from your 401(k) or IRA right now? Obviously, it depends on your current financial situation. Many pundits are saying that if you are able to continue paying your bills and feed your family you should leave the money alone and remember that your retirement money is for just that: your retirement.

Thinking Short Term

The new 401(k) and retirement rules were made with those who are experiencing a crisis currently in mind. Therefore, if you have become unemployed and cannot live off the unemployment insurance you are paid or have a medical emergency arise, then it might be a good time to take advantage of the new tax rules. Even with the 10% penalty, many people take out money from their retirement account to cover medical bills, educational expenses, to pay off other debt, or to make large purchases.

Just keep in mind that because you are withdrawing from your pretax retirement savings, you must pay income taxes on your withdrawal. The good news is if you absolutely must take an emergency distribution from your retirement account, which is taxable, you can re-contribute that money back within three years, even if you have already reached your contribution limit for the year. This means that you can effectively spread the taxes over the course of three years.

Thinking Long Term

Most individual investors and even experienced traders are not effectively able to beat the market year after year, and so investors will be better off leaving their retirement funds right where they are for now. Considering the opportunity costs of a penalty-free withdrawal, you may be applying a long-term solution to a short-term problem. Think about it this way, if you take out just $10,000 today, you could be costing yourself roughly $47,400 over the course of 30 years.

Investors faced with a cash shortfall should first look in other alternatives before tapping into their retirement. Alternative sources of income include borrowing the money from family or friends, taking out a personal or business loan, or selling off more liquid assets such as stocks. Some 401(k) accounts can be used as collateral for a low-interest personal loan, and the amount that can be borrowed against has been increased from $50,000 to $100,000 for the next six months. Just make sure that you weigh the costs of the interest from a personal loan with the taxes you might pay on an early withdrawal from your retirement savings.

Final Answer to the 401(k) Dilemma

Ensure you have read the rules of your 401(k) or other eligible retirement programs and reach out to your human resources department or plan administrator before you do anything. There could be rules against hardship withdrawals that could cost you extra fees or prevent you from making an early withdrawal.

It is also important to note that while you may not be able to control the events outside your personal life, you can manage your behavior. With that said, it is crucial not to make long term decisions based on temporary events or from a fear-based perspective. It is equally important to seek out the sound advice of an experienced financial professional before making a move to cash out part of your retirement savings.

Get Professional Advice

If you feel that you should make a change in your retirement funding or have an idea that you think could be beneficial for your long term financial plans, now is the time to reach out to your financial advisory partner, retirement planner, or accountant to ask them about the implications of your strategy. It is always best to get professional help with anything that has long term personal or financial implications, and this is doubly true in today’s volatile environment.

If you need assistance with helping plan your future, feel that your plan needs an adjustment, or want to reassess your financial portfolio for more diversification, contact Lawhorn CPA Group. Our financial advisory and accounting experts have a wealth of knowledge that is waiting to be tapped into. Contact us today by calling (865) 212-4867 or by visiting our contact form online.

We look forward to assisting you!