No doubt, the pandemic has caused financial unrest for many.
With more Americans filing for unemployment and many finding it difficult to pay rent and mortgages, many are asking themselves if now is the right time to tap into their retirement accounts and accept the penalties. For some, retirement funds appear to be the biggest pot of money and therefore the most enticing to take money out of.
What is the penalty for tapping into your retirement accounts early?
Withdrawing money from your retirement accounts (IRAs, 401(k)s, 403(b)s, TSPs, etc.) before the age of 59 ½ may result in a 10% tax penalty in addition to any federal and state income tax on the amount you withdraw.
For example, if you withdraw $20,000 from your IRA, you’ll owe $2,000 as an early withdrawal penalty plus any federal and state taxes on top of that depending on your income level.
With the current pandemic, the stimulus package passed in March allows the penalty to be waived… with caveats of course.
The 10% early withdrawal penalty is waived for those under age 59½ who are suffering demonstrably adverse consequences due to COVID-19. Adverse consequences include being ill with COVID-19 yourself or taking care of someone with the virus, being laid off, furloughed, having your hours reduced, business closing (in the case of someone who is self-employed), or if you are unable to work due to childcare responsibilities. This waiver of penalty is retroactive to January 1, 2020.
The caveats to this are:
Total withdrawals may not exceed $100,000 aggregate
The early withdrawal must be repaid in three years if you do not want to pay taxes on the distribution taken from a tax deferred retirement account
What are some alternatives to tapping into retirement funds?
Take out a low-interest loan. Interest rates are at an all-time low currently. With some interest rates as in the single digits for personal loans, taking out a loan that you can afford may be preferable to dipping into your retirement accounts where taxes and penalties are in the double digits.
Negotiate a lower rate. Outstanding debt has the potential to be negotiated. Whether it is a mortgage, credit card balances, or personal loan, there is a potential it could be refinanced or negotiated. Contact your lender to see if they offer forbearance or negotiate a lower monthly payment or interest rate.
Start a side hustle. Finding alternate sources of income is one way to replace lost income or build up cash reserves.
Pick up more hours at your current job if you’re hourly. Depending on where you work, this may not be an option, but it doesn’t hurt to ask.
Is this something that can wait? Short of an emergency, life decisions like purchasing a new home or car are decisions that could wait. If it’s not something you need to spend the money on right now, wait.
THE BOTTOM LINE:
During times of financial hardship, withdrawing money from your retirement account such as an IRA, 401(k), etc may seem like an easy first stop to get money you need. However, if you are under age 59 ½, tapping into your retirement accounts should not be your first resort to relieve your financial burden because you will encounter penalties and taxes. At the end of the day, explore all alternative methods before dipping into the retirement savings you worked so hard to build up.