As the economic consequences of the coronavirus unfold, you may be experiencing challenges from job disruption and market volatility. The recently passed Coronavirus Aid, Relief and Economic Security (CARES) Act offers financial relief for individuals and families directly affected by the virus.
In addition to the direct stimulus payments and expanded unemployment benefits you’ve probably heard about, the act temporarily changes some rules for how individuals can take savings from their retirement plan accounts. I want to focus specifically on the provisions that expand access to qualified distributions and loans from retirement savings. As you read on, be aware that not all employer's retirement plans will offer the ability to take advantage of the loans and withdrawals CARES Act provisions.
Briefly, the CARES Act temporarily increases maximum limits for loans and waives the federal penalty and withholding for distributions taken from qualified retirement plans. Individuals who meet certain coronavirus-related eligibility criteria can take distributions of up to $100,000 across all of their plans or IRAs, or loans up to $100,000 or 100% of the vested account balance if it is under $100,000. Loans must be taken within 180 days of the March 27 enactment.
This may sound like a good idea. However, just because you can access this money doesn’t mean you should. Distributions and loans take money out of your account, so you’ll have to save more in the future to replenish it. If you have fewer savings working for you over time, you may have less money to retire. In addition, you could also face a large tax bill depending on the option you choose, though you have three years to pay the taxes.
Before taking money from your retirement account, I encourage you to explore other actions. You should also discuss your personal situation with your financial consultant and tax and legal advisors.
Take advantage of unemployment benefits
Sign up for unemployment benefits right after a job loss to receive an additional $600 per week through July 31, 2020. Thirteen more weeks of benefits will be available after July 31, 2020, if you are actively searching for employment.
Use your current cash flow if someone in your household is working
Use your current cash flow to cover as many expenses as possible. You can also consider reducing or stopping contributions to 529 college savings plans and other investments to increase your take-home pay. If you have to turn to your retirement savings, try reducing contributions rather than stopping them altogether. See if you can contribute enough to earn your employer match, if available, to keep some savings working for your future. Remember, you can borrow for most goals, but you can’t borrow for retirement.
Turn to other savings
Whether you lost your job or your current pay does not cover expenses, you may need to tap into an emergency account, if you created one. Ideally, those savings can help you weather several months of expenses. Also, consider liquidating assets such as bonds you may have in other non-taxable accounts. Be cautious, however, about selling stocks you may have in these accounts right now. With the current market volatility, you could be selling at a loss.
Trim expenses to minimize costs
Next, identify any expenses you can reduce or eliminate. Weigh the potential savings against the benefit the item or service offers you, and choose options that you can live with. Perhaps you don’t want to reduce cable service while you shelter in place, but could make coffee at home and forgo some trips through the drive-thru. It’s easy to forget about automatic recurring bills. Check if you can suspend payments, especially for services that had to close due to social distancing requirements.
Remember any small pleasures you give up temporarily can be reinstated when your situation changes.
Explore payment plans and modifications
Many companies are making provisions to reduce or defer payments to help customers throughout this period of uncertainty. Don’t be afraid to ask about assistance programs for rent, utilities, loan payments and some credit card bills.
Turn to your retirement account last
Only when you’ve exhausted all other options should you turn to your retirement plan account. There are pros and cons to taking distributions or loans (if allowed in your plan), so it’s important to fully understand the repayment, tax and other implications before making a decision.
If you must take retirement plan savings for immediate financial needs, I recommend you start with the loan option because you are committing to repay it in three years so your money can continue to work for your future. Before taking a loan, you should also consider:
- These loans typically have lower interest rates than other types of borrowing, like a credit card.
- There may be fees associated with the loans.
- You will have to pay off your loan, either in payments or as a lump sum, if you leave your job.
- The IRS does not extend after-tax contribution status to loan payments made with after-tax dollars, so you will pay taxes again on your loan repayment amount in retirement.
Distributions from your retirement plan should be one of your last choices. You aren’t required to pay distributions back; in fact, it is a risk that you won’t, which can be costly. By taking money out of your retirement savings now, you could forgo potential future growth, which may mean less money for your future.
While the CARES Act temporarily waives penalties and withholding for coronavirus distributions, you will pay income tax on any pretax contributions you made, contributions from your employer and any investment earnings.
Get help before you act
As you can see, replacing income with a loan or distribution requires knowledge and careful consideration during these challenging times. A financial consultant can help you evaluate your options to support both your short- and long-term financial goals. At TIAA, we’re here to help you navigate this period of uncertainty.