Individuals who have suffered a financial impact due to the coronavirus pandemic may consider tapping their retirement savings to meet current financial needs. However, if you are someone who is considering dipping into your retirement, you should first consider the impact that taking a withdrawal could have on your lifetime retirement savings.
The Federal Government passed the Coronavirus Aid, Relief, and Economic Security Act (CARES) Act, which provides an attractive withdrawal option compared to other options such as traditional plan loans or hardship withdrawals. These Coronavirus-related Distributions (CRDs) provide these options:
- Allows for withdrawals of up $100,000 or 100% of the plan balance
- Waiver of the 10% early withdrawal penalty
- Ability to spread the income tax over three years rather than all in 2020
- Opportunity to repay the amount of the withdrawal within three years of distribution
For someone thinking of taking a CRD, below are four considerations that highlight the impact withdrawing money from your retirement could ultimately have on your retirement savings.
- Selling in a down market – The markets have taken a sharp downturn. To raise the money for a CRD, you will need to sell assets within your plan. By doing this, you are locking in those losses and giving up any opportunity to regain them as markets stabilize and return to pre-coronavirus levels.
- Time it took to save that amount – You should consider how many years it took to save the amount you are considering for a CRD. If someone took a $20,000 CRD and had been saving $5,000/year in their retirement account, it will take four years of continued savings to get that same amount back in their plan. The impact will be even greater if you reduce or suspend current contributions.
- Repayment Option – While repayment of this amount is an option, it is unlikely that many individuals will do so. Current annual contribution limits are $19,500, which is more than many individuals save in their plans each year. Also, if you do repay the amount, you will need to file amended tax returns to recapture any taxes already paid. If you intend to repay a withdrawal it may be beneficial to consider a plan loan instead of a withdrawal.
- Taxes – Even though you might be avoiding the 10% early withdrawal penalty, CRDs are still subject to state and federal taxes. In addition, typical withdrawals require 20% tax withholding at the time of distribution, which is held to cover the future tax. Although, the tax withholding rule does not apply to CRDs. This ability to avoid holding anything back for future taxes may result in covering an expense now but creating one later when you complete your tax returns.
Early withdrawal from a retirement plan may seem like a good way to leverage savings to cover short-term needs. However, this could have a significant long-term impact on your ability to retire. Early withdrawals from retirement plans are often considered a ‘last resort,’ and that is no different even in today’s environment.
Multnomah Group is a registered investment adviser, registered with the Securities and Exchange Commission. Any information contained herein or on Multnomah Group’s website is provided for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Multnomah Group does not provide legal or tax advice.