The effect of the COVID-19 pandemic lockdown is felt far and beyond. The lockdowns and quarantines that were necessary to curb the spread of the virus slowed the economy with unprecedented force and speed. Businesses racked up losses, and layoffs and pay cuts followed. With increasing rate of unemployment, many families are struggling to meet their day to day expenses. If you are facing financial hardship due to COVID-19, you may have considered making a 401(K) withdrawal early to cover your expenses.
Financial experts do not recommend taking money out of your retirement accounts early, but now taking into consideration the present economic scenario, most of them say that if you must, you should, as alast resort.
In the wake of the coronavirus pandemic, President Donald Trump signed the CARES Act on March 27, 2020, providing more than $ 2 trillion in financial relief for businesses and workers affected by the pandemic. If you are considering a 401(k) withdrawal, there are certain things you need to know.
Withdraw money of up to $100,000 without penalty.
Under normal circumstances, if you’re under 59 1/2, withdrawing from a 401(k) is a costly proposition because you are charged a 10% penalty on withdrawn funds. The recently introduced CARES Act changes that. This means you can make COVID-19 related withdrawals of up to $100,000 from your retirement account without incurring this penalty on early withdrawals.
Although the removal of this penalty takes off one of the substantial burdens of taking out the money from a 401(k) early, raiding your retirement accounts is still be a costly proposition because you lose out on the compound interest your money would’ve earned if it had stayed invested.
So, early 401(k) withdrawal is now penalty-free, but is it completely tax-free? No.
Income taxes apply to the withdrawal amount, but the repayment can be stretched out over three years.
Withdrawing money from your 401(k) will still have tax consequences. Regardless of how old you are, when you take out money from your retirement account, you will be taxed as normal. But the CARES Act allows you to stretch the repayment of the taxes over three years instead of paying the entire amount this year. This arrangement provides some financial relief as the taxes can be substantially large, even without penalties.
Can you put back the withdrawn money over the next three years?
Yes. If you’ve taken a coronavirus-related distribution, the CARES Act allows you to put the money withdrawn back into the account over the next three years. The money that you put back will not be counted against your annual contribution limits, and hence you will not be liable to pay any income taxes on that. But, if you are unable to repay the borrowed amount due to financial constraints over the next three years, income taxes will be applied.
You may have the option to make an early 401(k) withdrawal, but should you do it?
The best way to determine whether you should take an early retirement distribution is to check if you have enough money to cover your living expense for the next 3 to 6 months. If you don’t and you find it difficult to manage these costs, then you should consider taking advantage of this.
However, before you decide to take this step, think of the bigger picture. You are raiding into your retirement savings and losing out on money that would have accumulated due to compound interest if you would have let it stayed into your account.
So, before taking this drastic step, always look at other sources of income or options. You can also consider taking help from a tax professional or financial planner to weigh the pros and cons of withdrawing from retirement accounts. For expert help,Contact Self Directed Retirement Plans LLC at (866) 639-0066.
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning company based in Goodyear, AZ. He has over three decades of experience working with investments and retirement planning, and over the last ten years has turned his focus to self-directed ira accounts and alternative investments. If you need help and guidance with traditional or alternative investments, call him today (866) 639-0066.