Early Withdrawal From Retirement Funds
Nov 17, 2020
Risks and Resources
COVID brought unexpected turns for almost everyone around the world. For those in the final chapter of their careers, the pandemic forced many to make the decision to either retire early or find a new job. A 401(k) or IRA can seem like a good resource to help you get by, either indefinitely or temporarily. But early withdrawals come with drawbacks, and may be too risky for certain individuals. Fortunately, there are new resources in place to help mitigate risks to your financial future.
When Should You Withdraw From Your 401(k) or IRA Early?
Ideally, you shouldn’t. But if you must cash out from your retirement funds before originally planned, only do so in an extreme emergency. Money from your emergency savings accounts should be used and your investments depleted before turning to retirement funds. Retirement plans are structured for long-term investing, and if you withdraw early you forfeit the benefits of tax-deferred earnings and compounding interest. Cashing out on your 401(k) or IRA before the age of 59 ½ can result in having to pay income taxes and a 10% penalty.
Due to the pandemic and other circumstances, not everyone has the luxury of waiting to use their retirement funds. Fortunately, there are resources in place to assist people who must rely on it. A hardship withdrawal allows individuals to dip into retirement funds without a penalty, depending on the reason, such as specific medical expenses, prevention of eviction or foreclosure, funeral expenses, or permanent disability. However, you will still be required to pay income tax at your regular tax rate, and you cannot replace the money you’ve taken out back into your plan.
The CARES Act, or Coronavirus Aid, Relief, and Economic Security Act, was created to provide economic relief to Americans and protect them from the impacts of COVID-19, and provides more financial flexibility to those not yet retirement age. It provides for expanded distribution options and favorable tax treatment for up to $100,000 of coronavirus-related distributions from eligible retirement plans, made between January 1, 2020 to December 30, 2020, as well as special rollover stipulations.
Section 2022 of the CARES Act allows individuals to borrow money from their 401(k) or IRA early without the 10% penalty fee, and increases the limit on how much a qualified individual may take out from an eligible plan. It also allows you to replace what you borrowed from your accounts back into your 401(k) or IRA without owing tax, even if the amount is more than the annual contribution limit for that account.
Although the act eliminates the 10% early distribution penalty, you still have to pay taxes on the withdrawn amount. A third of the money you withdraw will be included as income in your taxes for each of the next three years, beginning with the year you receive distribution. Or, you can elect to include the entire amount in your income the year of distribution.
How Do I Know if I’m Qualified?
The IRS states that qualified individuals include:
- Those diagnosed with SARS-CoV-2 or COVID-19 by a test approved by the Centers for Disease Control and Prevention
- A spouse or dependent who is diagnosed with SARS-CoV-2 or COVID-19 by a test approved by the Centers for Disease Control and Prevention
- Those experiencing adverse financial consequences as a result of being quarantined, furloughed or laid off, or having reduced work hours due to SARS-CoV-2 or COVID-19
- Those experiencing adverse financial consequences as a result of being unable to work due to lack of child care due to SARS-CoV-2 or COVID-19
- Those experiencing adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to SARS-CoV-2 or COVID-19
Times like these can be scary. But there are resources to help you prepare for uncertain situations. Savings accounts exist just for these kinds of things—use yours before considering withdrawing from funds that exist to provide for you for the rest of your life. Talk to a financial adviser before making lasting financial decisions. An experienced retirement planner, like those at Charles Stephen, will know the details of your options and will help you create a plan tailored exactly to your circumstances and your needs.