With so many Americans in a financial crisis, families are looking at all their options to find the money they need. Sixty-one percent of Americans say their emergency savings won’t last through the end of the year, according to a recent survey by the real estate servicing company, Clever. To close the gap, one option still available under the CARES Act is to withdraw from your IRA, 401(k), or 403(b).
Prior to the passage of the CARES Act, you couldn’t make withdrawals before you were 59 1/2 years of age without taking a significant 10% penalty for the early withdrawal, and you’d pay taxes on that amount as well. The CARES Act temporarily changed the rules: Now you can withdraw $100,000 as a distribution without the early withdrawal penalty, and the tax burden can be spread out over three years. If you can pay back the amount you took within three years, you can claim a refund on those taxes.
To qualify, you must have been specifically impacted by COVID—and this includes anyone who has experienced “adverse financial consequences” from the pandemic (a very low bar for most people). The deadline for taking distributions under these special rules is December 31.
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When should you withdraw? Ideally, not until you’re ready for retirement. The earlier you save for retirement and make regular contributions, the more it compounds over time. For example, the $100,000 you could withdraw today, at a growth rate of five percent, would be $160,000 in 10 years even without any additional contributions.
It’s advisable to exhaust all other savings or find new sources of income before you touch your traditional retirement accounts. Another option to consider is focusing on your Roth IRA, if you have one. Unlike 401(k) or traditional IRA withdrawals, if you have a Roth IRA you might be eligible to withdraw contributions penalty- and tax-free if you’ve had the account for five or more years.
“A lot of folks are in a bind and most just have a 401(k), but no other retirement,” says Jorge Soriano, a Financial Advisor at GTE Investment Group, who spoke with me via email. “Therefore, they are just withdrawing to make ends meet to pay for rent, mortgage, and car loans.”
In this scenario you would be using cash to cover debt that is otherwise impossible to pay. If you’re facing eviction or need money to pay for utilities or other essential needs, you will want to project how much money you’ll need to stay afloat before making your withdrawal.
With a CARES retirement withdrawal you are given three years to pay yourself back if you want to avoid the taxes, which are interest-free. In this case, you could use the money to pay down a high-interest credit card or personal loan with a high interest rate, like 18% to 20%. This has some risk, however: If you aren’t able to pay back the retirement withdrawal within three years, you’ll end up owing back taxes.
Your safest strategy is to take as little as possible from retirement savings and have a plan for paying back that amount within three years. To make a withdrawal from your IRA or 401(k), call your financial provider directly and they will walk you through the steps. If you don’t know who your 401(k) provider is, ask your employer. That said, it’s strongly recommended that you to consult with a tax advisor before withdrawing from your savings.