The coronavirus pandemic has touched every aspect of each American’s life.
Money may be the top issue for many, especially if you’ve lost your job or had your hours cut.
The Senate just passed a $2 trillion stimulus package — the Coronavirus Aid, Relief and Economic Security Act, or CARES Act. The House is expected to vote on it Friday. Among other benefits, the bill would change how people can access retirement savings.
The early withdrawal penalty for borrowers younger than 59½ is gone for amounts up to $100,000. It’s easier to take out a loan (also up to $100,000) or borrow against the account.
But there are several caveats to keep in mind.
First, you are selling at a loss after the market dipped so steeply, says Chad Parks, founder and CEO of retirement plan provider Ubiquity Retirement and Savings in San Francisco.
Next, you will lose out on future gains.
“Let’s say you have 10 years of compounding,” said Thomas Henske, a certified financial planner with Lenox Advisors in New York. “Your money would double, given a 7% rate of return over that time.” In other words, if left untouched, your $100,000 could eventually add up to $200,000.
Research shows that people who didn’t tap retirement funds during the last downturn had better financial recoveries.
Another important factor — taxes — is a big gotcha, Parks says. “Just because they’re waiving the penalty, doesn’t mean they’re waiving the taxes,” he said. (If you live in California, you’ll also still have a state penalty of 2.5% on the early withdrawal.)
If you were making traditional pretax contributions, you’ll have to come up with a tidy sum when you file your taxes next year. “Using a round number of 20% or 25%, depending on your income and tax bracket, that’s a good number to plan for,” Parks said.
Thus, the $20,000 you take out now will cost you around $4,000 to $5,000 next year — so it’s really only $15,000 or $16,000.
Consider a loan from a 401(k) over an early withdrawal, Henske says.
Say things clear up all of a sudden, at the end of April. “That would be only one month of loan expenses that you can quickly make up and put back in,” Henske said.
Try tapping a home equity line of credit if you already have one established.
If you are without income, remember that you may have unemployment benefits. Parks recommends researching online how much you may get. You might receive up to $600 a week through the federal unemployment benefit enacted under the CARES Act. On top of that, varying state benefits raise the weekly amount. In California, for example, the state maximum is $450 a week.
The strategy to help you get through a few months and preserve your savings is similar to making a budget in normal times.
First, calculate the minimum you need to get through a month: mortgage or rent, transportation, food, routine medical expenses and utilities.
Compare that number with any income. Subtract your expenses and see if the result is positive or negative. If negative, figure out how much you need to make it a positive number.
Next, check statements from all your credit card accounts to see how much available credit you have. It’s impossible to know how long the current situation could last, but Parks believes it is safe to plan on covering your deficit for at least six months.
“You’ll either find another job or get some government assistance or your job may be restored,” Parks said. “Don’t think you’re never going to have another source of income.”
If you have $15,000 in available credit and a monthly shortfall of $1,000, that could mean 15 months of runway, Parks says. “You’ll pay interest, but you have to promise yourself that you will immediately turn around and pay it down.” This strategy works best if you commit to paying the balance down as soon as life and finances become more stable.
Say you need $10,000. “I guarantee you’ve got $10,000 on a credit card, or at least a few of them cumulatively,” Parks said. “It’s a short-term thing to get you through.”
If six months passes and you’re still facing a cash crunch, repeat the income/expenses exercise. You may then decide to dig into retirement savings — but leave that as a last resort.
The last reason to tamper as little as possible with your retirement money, Parks says, is a worst-case scenario.
If someone finds they need to go through bankruptcy, a qualified retirement account offered by an employer, such as a 401(k) or a 403(b), is a protected asset that cannot be touched by creditors.
“I’m not promoting [bankruptcy],” Parks said, “but if you want to be a realist, these are tough decisions.”