As millions of workers await additional coronavirus relief, and Congress weighs the possibility of sending Americans an additional $2,000 a month throughout the pandemic, many people are considering withdrawing from their retirement fund.
This is in large part because the Coronavirus Aid Relief and Economic Security (CARES) Act allows individuals to withdraw from their retirement accounts before the age of 59½ without facing the usual 10 percent penalty for an early disbursement, provided they’ve been adversely affected by COVID-19.
Additionally, if the withdrawal is from a tax-deferred account, individuals taking an early disbursement won’t have to pay taxes, provided they pay back the amount taken out within three years.
Income from a qualifying distribution is included pro rata across the next three tax years, unless the taxpayer chooses to include it all this year. While the taxpayer could pay the distribution back at the end of the three years and owe no tax on the distribution, they would have paid tax on a portion of the distribution during each of the first two years and need to file amended returns to reclaim their tax payments.
The only way to not pay tax on the distribution at least temporarily would be to pay back the entire distribution this year.
Given that unemployment numbers continue to rise, with the Department of Labor reporting a loss of 20.5 million jobs in April, it’s likely that some workers with retirement savings may dip into their accounts for a necessary reprieve.
However, with the looming possibility that many professionals will face salary cuts upon returning to work, individuals considering an early withdrawal need to exercise an abundance of caution to ensure their accounts don’t run dry too soon.
Should I Withdraw From My Retirement Fund During the Coronavirus Pandemic?
Determining whether to take an early disbursement from your account will be determined by a number of personal factors, including how much you have saved, how much you need to retire comfortably, and how much longer you anticipate to remain in the workforce.
Do You Absolutely Need To?
Your first consideration should surround whether this withdrawal is absolutely necessary — or whether you can make up for lost income by shifting your budget.
“It’s important to first consider if you need these funds as an income supplement, or if you can make do by reducing expenses,” says certified financial planner Michael Kothakota of Wolf Bridge Financial. “Think about how much you actually need to withdraw, and whether or not you’ll be able to replace the money.”
You’ll also want to weigh how a disbursement now will affect the value of your account in the long run, given that taking money out now deprives these investments of future growth once the market swings back to normal.
“Taking moderate and appropriate risk with long-term retirement funds is the prudent approach,” remarked financial education expert and CentSai columnist Peter Neeves, Ph,D., in a previous post. “That money needs to grow, to be worth more when the time comes that you need it.”
Tax Implications of Withdrawing From a Retirement Fund During Coronavirus
Additionally, consider the tax implications, and the possibility that you may not be able to pay back the amount taken out within three years, before dipping into your IRA or 401(k).
“Once you fully factor in the taxes of withdrawing from your retirement account, even with the early withdrawal penalty waived for qualifying reasons, this option may not be the most attractive,” says financial advisor Wesley Botto, a partner at Cornerstone Financial Group. “If you make a withdrawal, I would strongly consider withholding the taxes so you don’t get hit with an ugly surprise later on.”
The Bottom Line
Understanding the risks, and potential losses, of an early disbursement can help you make the decision that’s best for you and your money. Following CentSai’s COVID-19 page can help you keep track of the economic fallout surrounding novel coronavirus, and help you prepare in confidence.
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