Yes, It’s a Crisis, But Read This Before Looting Your 401(k)
$1 spent today could be $2 to $7 or more in retirement; other ways to stay solvent
Imagine that thanks to the economic crisis around COVID-19, you or a family member lose a job, and even with expanded jobless benefits you’re short on cash. Your 401(k) comes to mind. After all, this is an emergency.
And Congress just made it easier for anyone, regardless of employment status, to take money out of a 401(k). New legislation waives the typical 10% penalty on withdrawals, up to $100,000, before age 59 ½ for 401(k)s and IRAs.
Please consider this first:
Try reducing your monthly bills. A welcome change from how things played out during the financial crisis that began in 2008 is that this time households can get immediate help. Some of the help is mandated by the federal stimulus bill, and some of it is much more ad-hoc, as many businesses are offering relief on a case-by-case basis.
The stimulus bill allows you to stop payments on federal student loans until Sept. 30, 2020. You will not be charged any interest or penalties during this time. Note: This only applies to federal student loans, not private loans.
Similar help is available to homeowners whose mortgages are owned by a federal agency (many are), and some states are requiring all lenders to offer mortgage relief to households impacted by the economic chaos.
There are no federal mandates for how car loans or credit card balances must be handled, but many lenders are working with consumers on a case by case basis to reduce or eliminate payments for at least a few months.
The key is that you need to contact all your lenders and ask what help is available. Don’t assume there is no help, and don’t assume that if you are entitled to a federal or state break that it will automatically be activated. Contact everyone you have a bill with — even your utilities — and ask what assistance is available.
If you reduce your current bills, that might give you breathing room to leave retirement accounts untouched.
Understand the tax you owe on retirement account withdrawals. When you make a withdrawal from a traditional 401(k) or IRA account, you owe income tax on every dollar taken out. That hasn’t changed.
Normally you would need to pay all the tax on a withdrawal in the year you make the withdrawal, but Congress has allowed those payments to be stretched over three years.
If you have money in Roth IRA or Roth 401(k) accounts, and you absolutely need cash now, consider tapping your Roths rather than your traditional accounts. Money contributed (you put in) to a Roth can be withdrawn without tax or penalty. But if you withdraw any earnings on those funds from a Roth, you may owe tax.
Take a few minutes to think about the future. Right now it is normal to think short term. We’re all in crisis mode. But before you tap retirement savings, try to slow down your racing brain. Imagine yourself at 65. At 70. At 90! That’s why you save for retirement. Your future (older) self will be so grateful for every dollar you don’t touch right now.
Don’t rush 401(k) decisions if you’re laid off. When you leave a job, if your account value is less than $5,000, your plan may insist on kicking you out. They may write you a check for the balance. That can be tempting to use right now. But remember, if it’s traditional 401(k) money, you will owe tax. The best move: Put it into a rollover IRA account at a discount brokerage within 60 days of getting a check, and you won’t owe any tax, and the money will keep growing for retirement.
Let’s say you had $4,500 in a 401(k). Cash it out right now, you might have $3,800 to $4,000 after paying tax. Instead, you could reinvest the money in an IRA, with no tax. Let’s assume it grows at an annualized 5% a year for 20 years. (Over decades, the long-term annualized return for U.S. stocks is around 10%. So 5% is conservative.) Your $4,500 will be worth around $12,000. If you’re a 20-something, $4,500 will be worth more than $32,000 by the time you retire.
If you have more than $5,000 in your 401(k) account and are laid off, you have three choices: Leave the money in the plan as long as you want, move it to an IRA rollover account, or cash it out.
We’re agreed that the last option is not advised, right?
I’ve covered in another column the technical ins-and-outs of staying in a 401(k)
or moving the money into an IRA here: https://www.rate.com/research/news/401k-rollover-cost Either way, that particular decision isn’t urgent right now.