The coronavirus has affected nearly every aspect of the way we live, and it's caused significant economic hardship for millions of Americans. Roughly 50% of U.S. adults say COVID-19 has affected their personal finances, a survey from Pew Research Center found, and 88% say it's had an impact on the U.S. economy.
As a result, Congress recently passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act to provide economic relief to individuals and businesses who are struggling due to the coronavirus pandemic.
One of the most notable features of the bill is the $1,200 stimulus check millions of Americans will be receiving. But there's a lesser-known aspect of the bill that could have a significant effect on your finances: You now have the opportunity to raid your retirement fund without facing a penalty.
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New retirement rules under the relief bill
Previously, if you wanted to withdraw cash from your 401(k) or traditional IRA before age 59 and a half, you'd face income taxes and a 10% penalty on the amount you withdraw. Under the CARES Act, though, you can withdraw up to $100,000 from your retirement account without paying the 10% penalty. Depending on how much you withdraw, this could potentially save you thousands of dollars.
You'll still need to pay income taxes on your withdrawals, but another change under the new bill is that you now have three years to pay those taxes. If you're making significant withdrawals, being able to spread your tax payments over three years can ease the financial burden.
Keep in mind, though, that these new rules only apply if you're using the money for coronavirus-related expenses. To qualify for penalty-free retirement fund distributions, either you, your spouse, or a dependent must have tested positive for COVID-19, or you must have experienced financial hardship due to being laid off, furloughed, or quarantined.
Is it a good idea to withdraw from your retirement fund?
These new regulations make withdrawing from your retirement fund more enticing, but is it a good idea to raid your savings? In general, the answer is no. Even if you won't pay a penalty and you can spread your tax payments out over three years, there are still short- and long-term consequences to withdrawing your savings before retirement age.
For one, right now is not the best time to take money from your retirement account because stock prices are at rock bottom. You may be tempted to pull your money out of your retirement fund now if your investments have taken a hit in recent weeks, thinking you can salvage your savings before things get worse. However, you don't technically lose any money until you sell your investments. So if you sell your investments now by withdrawing your cash, you're locking in your losses by buying high and selling low. If you keep your cash invested, though, you'll reap the rewards once the market recovers.
There are long-term consequences for withdrawing your cash, as well. Your investments rely on compound interest to help them grow, so the key to building a robust retirement fund is to leave your money alone for as long as you possibly can. Every time you withdraw your money, you're essentially taking a step back and starting over. The less time your money has to grow, the more challenging it will be to accumulate a significant amount of cash.
Tapping your retirement fund should be a last resort, and even then, it may be wiser to borrow the money rather than withdraw it. The CARES Act also loosened the regulations around 401(k) loans, allowing savers to borrow the full vested amount in their 401(k) up to $100,000 (previously, borrowers could only receive loans of 50% of their vested balance up to $50,000). With a 401(k) loan, although you do have to pay the money back, that can be a good thing because it forces you to keep contributing to your retirement fund -- which can help keep your savings on track.
Millions of Americans have been personally affected by the coronavirus, and some people may have no choice but to tap their retirement funds to make ends meet. Although raiding your retirement savings may not be ideal, the good news is that it's now less expensive to withdraw your cash. Not only will that save you money, but it can also make these difficult times a little easier.
FAQs
You may be able to make a 401(k) withdrawal before age 59½, but it could trigger a 10% early distribution penalty, on top of ordinary income taxes. Some reasons for taking an early 401(k) distribution are penalty-free, such as a hardship withdrawal or if you leave your job.
What is the safest retirement withdrawal rate? ›
As a rule of thumb, many retirees use 4% as their safe withdrawal rate—the so-called 4% rule. The 4% rule states that you withdraw no more than 4% of your starting balance each year in retirement, adjusted each year for inflation.
Should I take money out of my retirement account? ›
It can be tempting to withdraw money from your retirement account when you're facing a financial rough patch, but this strategy should generally be considered as a last resort. In addition to the taxes and penalties you'll pay, you're also robbing your future self of money for retirement.
Why is it important to not take your money out of a retirement fund? ›
Sure, the cash you take out is helping you with some short-term needs. However, you lose the long-term growth potential that your money could have within your retirement account. Your retirement account is designed to grow over time through compounding interest, potential dividends, and participation in market growth.
How do I avoid 20% tax on my 401k withdrawal? ›
Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.
How do I avoid paying taxes on my IRA withdrawal? ›
To avoid taxes on IRA withdrawals, consider the following strategies:
- Convert to a Roth IRA. Consider converting traditional IRA funds into a Roth IRA. ...
- Use Roth contributions. If you have a Roth IRA, prioritize contributions to it. ...
- Delay withdrawals.
There are several approaches you can take. A traditional approach is to withdraw first from taxable accounts, then tax-deferred accounts, and finally Roth accounts where withdrawals are tax free. The goal is to allow tax-deferred assets the opportunity to grow over more time.
What is the 4 rule for retirement withdrawal? ›
The 4% rule limits annual withdrawals from your retirement accounts to 4% of the total balance in your first year of retirement. That means if you retire with $1 million saved, you'd take out $40,000. According to the rule, this amount is safe enough that you won't risk running out of money during a 30-year retirement.
What is the Morningstar 4% rule? ›
The 4% rule suggests that retirees can safely withdraw 4% of their portfolio in the first year of retirement and then adjust that amount annually for inflation over the course of at least 30 years without having to worry about ever running out of money.
How much money should you have in your bank account when you retire? ›
By age 40, you should have accumulated three times your current income for retirement. By retirement age, it should be 10 to 12 times your income at that time to be reasonably confident that you'll have enough funds. Seamless transition — roughly 80% of your pre-retirement income.
If you're at least age 59½ and your Roth IRA has been open for at least five years, you can withdraw money tax- and penalty-free. See Roth IRA withdrawal rules.
At what age is 401k withdrawal tax free? ›
Employer-sponsored, tax-deferred retirement plans like 401(k)s and 403(b)s have rules about when you can access your funds. As a general rule, if you withdraw funds before age 59 ½, you'll trigger an IRS tax penalty of 10%.
How can I withdraw money from retirement without penalty? ›
Hardship Withdrawals
Individuals may be eligible to take early distributions from their 401(k) without penalty if they meet certain criteria with a hardship distribution. It requires an immediate and heavy financial burden they couldn't afford to pay.
Can you lose your retirement fund? ›
A number of situations could put your pension at risk, including underfunding, mismanagement, bankruptcy, and legal exemptions. Laws exist to protect you in such circ*mstances, but some laws provide better protection than others.
Should I cash out retirement to pay off debt? ›
Eliminating debt can bring immediate financial relief, but dipping into your 401(k) or IRA to do so can jeopardize your future financial security. While the idea of becoming debt-free might be appealing, tapping your 401(k) or IRA is generally a bad idea.
Can I withdraw from retirement while still working? ›
You're not age 55 yet
A penalty tax usually applies to any withdrawals taken before age 59 ½. And typically, you can only withdraw from 401(k) plans at previous employers. For a 401(k) offered by your current employer, usually, you can't take withdrawals while still working there.
What is the rule for retirement withdrawal? ›
The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.
Can I withdraw cash from my retirement account? ›
You can withdraw part of your Retirement Account (RA) savings (excluding interest earned, any government grants received and top-ups to your retirement savings) down to your Basic Retirement Sum if: You are 55 and above; You own a property* with remaining lease that can last you to at least 95; and.
How much money can I withdraw from my retirement account? ›
The sustainable withdrawal rate is the estimated percentage of savings you're able to withdraw each year throughout retirement without running out of money. As an estimate, aim to withdraw no more than 4% to 5% of your savings in the first year of retirement, then adjust that amount every year for inflation.
