When a serious financial emergency hits, like the COVID-19 crisis, it’s only natural to get a bit anxious. To help ease the financial pain, it’s easy to look toward the largest pot of available money, which for many people is their 401(k) plan. Recent legislation due to the COVID-19 pandemic allows account holders to withdraw up to $100,000 from their 401(k) plans without paying penalties, just taxes. However, dipping into your retirement account under these circumstances is rarely the right call. For starters, making any financial decision based on emotion — especially if that emotion is panic — can have devastating long-term consequences. Secondly, accessing your 401(k) prematurely can cause financial damage, from the taxes you’ll owe to the shortfall you’ll have in your retirement savings. If you find yourself in a serious financial bind, consider some of these options before you decide to raid your 401(k) plan early.
Your emergency fund is usually designed to cover unexpected expenses like a major car repair or a medical expense that isn’t covered by insurance. However, financial emergencies count as well. If you’ve got no income and your bills continue to pile up, consider tapping at least a portion of your emergency fund rather than drawing from your 401(k) plan. Although you never want to deplete your emergency fund unless you have to, if the only alternative is paying fees and taxes and raiding your 401(k), that qualifies as an emergency all its own.
Your regular savings account is likely intended as either a parking place for excess cash or a bucket to collect funds for short-term goals, such as buying a house. In times of severe economic strain, like the COVID-19 pandemic may be creating, you might have to reconsider some of your short-term goals. If you find yourself out of a job, for example, you may have no choice but to defer your homebuying dreams for a few months or years. If drawing from your savings account means you can avoid tanking your retirement, it might be a short-term compromise you should consider.
If there’s a silver lining to all of the damage caused by the COVID-19 pandemic, it’s that interest rates are at all-time lows. This means that there’s never been a better time to take out a loan. Credit unions and other lenders are offering personal loans with low single-digit interest rates, making them a relatively affordable way to get emergency capital. Although borrowing money isn’t always the best idea if you’re already in debt, if you can get a low-rate loan that you can still afford to pay back, that may still be preferable to taking money out of your 401(k), especially with stock markets down over 20% from their highs.
0% Balance-Transfer Credit Card Offer
If you can get a 0% credit card balance-transfer offer, it might be time to take advantage of it. Although interest rates are at all-time lows, banks may start tightening their lending requirements to protect themselves against losses. This means that customer credit lines may shrink, and applications for new credit may be denied. With many 0% balance-transfer offers, you can actually deposit the money directly into your own bank account via what is known as “convenience checks.” This can give you immediate, low-cost access to funds at a time when you need it, which can be a better option than taking an early 401(k) withdrawal.
Picking Up Extra Hours at Work
The COVID-19 pandemic is clearly hitting American workers hard, with more than 30 million people filing for unemployment as of the end of April 2020. If you are fortunate enough to still have your job, you might consider asking for more hours. Although your employer may be looking to cut costs, if you still have your job, it’s possible your employer is not as affected as others and may even be thriving. You also may be a key employee if you’re still on the payroll. No matter the situation, it couldn’t hurt to ask if there’s additional work available, especially if your alternative is to drain your retirement account early.
The best way to replace lost income or to build up a cash reserve is to find another source of income. In the age of the gig economy, it’s never been easier to look for online opportunities to earn an extra buck. Although opportunities are no doubt less plentiful due to the COVID-19 recession, there are still plenty of people and companies hiring workers to handle tasks, one-time projects or even full-time gigs online. Even if you’ve managed to keep your job and work from home during the crisis, you no doubt have some extra time on your hands due to the nationwide stay-at-home mandates. Turn some of that spare time into extra cash to help get you through this rough patch without drawing down your 401(k).
In a time of record-low interest rates, you might consider raising extra cash via a home mortgage refinancing. If you can cut your payment by a few hundred dollars per month, you can use that extra money to pay off bills or build an emergency fund. Over the long run, you could end up saving thousands of dollars, and in the meantime, your 401(k) money could remain invested.
401(k) Loan -- New Parameters
One way to access the money in your 401(k) without triggering taxes and penalties is to take a 401(k) loan. Before the COVID-19 pandemic struck, 401(k) loans were allowed up to the lesser of 50% of your vested account balance or $50,000, with employer permission. Recent legislative changes now allow loans of up to $100,000 or your total vested balance. While the money is out of your account, it won’t be growing in your account anymore, but the interest you pay on the loan goes back into your own account. Overall, this arrangement is preferable to an outright withdrawal, but check with the IRS and your employer about various restrictions, particularly those that treat loans as distributions if you cannot pay them back after being separated from service.
Smart Moves: 6 Things To Do With Your 401(k) Right Now
Negotiate Lower Rates
If you’ve got existing outstanding debt, this would be a good time to try to negotiate your rates lower. With global interest rates so low, it’s likely that any loan you took out in prior years now carries a lower rate. You may have to negotiate for a lower rate, or you may have to refinance or buy out your existing loan to get a lower rate. At the very least, it’s worth it to ask and see what you can get. The same is true for your credit card balances, which generally come with sky-high rates. If you can get those rates lower, your monthly interest charges could decline significantly.
If money is really tight, before you begin withdrawing from your retirement plan, consider reducing your contributions as a first step. If you’re socking away a lot of money into your plan, reducing or even temporarily stopping your contributions could result in just the amount of cash flow savings that you need. For example, if you put away $1,000 every paycheck, cutting that to $500 or $0 could put some much-needed cash in your pocket without having you draw down your retirement savings.
Use Your Health Savings Account
A health savings account allows tax-free withdrawals for qualifying medical and health expenses. However, you can also use it as an emergency fund if you’re good at saving receipts. If you paid out-of-pocket for any medical expenses since you opened your HSA, you can take tax-free withdrawals in an equivalent amount, even if you’re not directly using the money you take out at the time of the expense. For example, if you opened an HSA one year ago and you spent $500 on eyeglasses six months ago, you can take $500 out from your HSA, tax-free, to cover that expense. This can come in handy during a time when you need emergency funds and are considering tapping your retirement plan.
Home Equity Loan
If you’re fortunate enough to have equity in your home, this may be a good time to consider using a home equity loan to tap those reserves. A home equity loan is a low-interest way to borrow against the value you have locked up in your home without having to sell your residence. With interest rates at all-time lows, it may never be a better time to consider a home equity loan as a way to keep your retirement money safe while still meeting your current need for income.
If you’ve built up some equity in your home, a cash-out refinance could be a way to solve your short-term cash needs. With a cash-out refinance, you borrow more than 100% of your home value, taking out the excess value as cash. While not always advisable, this is one way to take out a low-interest loan to get the cash that you need. With rates so low, this type of refinancing is booming.
If yours is like the typical American household, you have a large accumulation of stuff you simply don’t need, want or use. Thanks to sites like eBay, Etsy, Craigslist and others, it’s easy to list those items for sale and find a ready buyer within days or even hours. Some items, such as old LP albums, have real collector’s value, and you may be surprised at how much money you can raise. If all you need is a quick fix of cash to avoid having to withdraw from your retirement accounts, consider the two-in-one solution that both declutters your house and raises needed funds.
Home Equity Line of Credit
A home equity line of credit is similar to a home equity loan, but it has much more flexibility. With a line of credit, you don’t actually have to draw down money and start making payments until you actually need the funds. This can keep interest charges at bay until it’s absolutely necessary that you need to borrow. Rates on home equity lines of credit are also currently quite low, making them an interesting alternative to withdrawing from your retirement fund early.
Use Stimulus Check
The U.S. government began doling out stimulus checks of up to $1,200 per individual in April 2020. For most couples, that means an immediate cash infusion of $2,400, or even more if you have eligible children. Most Americans already received their checks via direct bank deposits. Assuming you’re on the eligible list, you can use your stimulus payment to pay your bills and put off any withdrawals from your retirement accounts. Keep your eyes open for new legislative action, as there are many in Congress who want to provide additional payments directly to the American people.
Get a PPP Loan
If you run a small business, there may be another avenue of assistance for you. The Paycheck Protection Program provides low-interest loans to businesses that have been impaired by the COVID-19 crisis. Some or all of those loans may even be forgivable if you use them to pay your employees’ wages during the crisis. A forgivable loan is essentially a grant, meaning you never have to pay it back to the government.
Apply for an EIDL
The Economic Injury Disaster Loan program is another loan program designed to provide assistance to small businesses in crisis. An interesting twist during the current COVID-19 pandemic is that small businesses can now apply for a grant of up to $10,000 that never has to be paid back. The details of the program have been changing, but currently, you can receive up to $1,000 per employee you have, with sole proprietors entitled to a $1,000 grant. This funding can help stave off the need to take out your retirement money instead.
Convert Investments to Income
If your investment portfolio is entirely growth-oriented, you might consider shifting your allocation to some income-producing securities, such as bonds or preferred stocks. You should consult with your investment and tax advisors before you make any changes to your overall portfolio, as it could alter your long-term returns. However, if you just need a temporary bump to your income, you can look at the available alternatives in the marketplace to see if they’ll meet your near-term needs.
Go From a One-Income Household to Two
Many two-person households prefer to have one spouse at work while the other handles the domestic side of things. In this tough environment, you might have to consider having both spouses take on some type of job. With remote working booming like never before, it might even be easier for the second spouse to find a job they can do at least part time while still managing the household. It can take some juggling, for sure, but having both spouses work is usually still preferable to raiding a 401(k) plan for funds.
Worst-Case Scenario: File Bankruptcy
Filing for bankruptcy is nearly always the worst-case scenario when it comes to your finances. However, there’s an interesting provision in bankruptcy law that makes it a more viable option in certain circumstances. Specifically, when you file for bankruptcy, your retirement assets are protected. This means that no matter how much debt you have, your creditors can’t go after your IRA or 401(k).
Although bankruptcy creates a lot of ancillary problems that are problematic, from the hit to your credit score to your inability to get a job in certain industries, it can be a good choice in some instances to preserve your retirement funds. For example, if you choose instead to take early distributions from your retirement accounts, you’ll still owe taxes (and sometimes penalties) on those withdrawals; if your financial problems are significant, you may end up drawing down your entire retirement account and still have to file bankruptcy when those funds run dry. Since bankruptcy can remain on your credit report for as long as a decade, it’s imperative to consult with a bankruptcy attorney if you’re considering this option in any way.
If You Must Withdraw From Retirement Accounts Early
In some cases, there may really be no other choice but to withdraw from your retirement accounts early. But even then, some options are likely better than others. If you’re in a true financial bind and see absolutely no option but to tap your retirement accounts, here are a couple of suggestions as to how to make that as painless and cost-free as possible.
Are You Over 50? You May Be Eligible for a Distribution
If you’re over 50 and have the right type of retirement plan, you may be able to take a tax- and penalty-free distribution. Certain plans, such as 403(b) and 457(b) plans, are similar to 401(k) plans and are used by tax-free organizations and/or state and local governments. These types of plans offer distributions to workers as young as age 50 without additional penalties. Even if you have a 401(k) plan, if you separate from service after age 55 you can take tax- and penalty-free withdrawals as well.
Withdraw Roth Contributions
If you have a Roth IRA, you have a leg up if you ever need emergency funds. Since Roth IRAs are funded with after-tax money, you can always withdraw your contributions to a Roth IRA tax- and penalty-free. For example, if you’ve put $20,000 in your Roth over time and the balance is now $50,000, you can withdraw the original $20,000 without paying any taxes or penalties. You’ll have to report this correctly on your taxes to avoid problems, so you may want to consult with your tax adviser before choosing this option.
Choose the Right Plan
It’s tough to get money out of your 401(k) plan under any circumstance. To even qualify for a hardship withdrawal, you’ll need to demonstrate an immediate and heavy financial need, according to the IRS, and you cannot withdraw more than the amount to satisfy that need. Even then, you’ll owe ordinary income tax and a 10% early withdrawal penalty, in most cases. IRAs have slightly different requirements to avoid the 10% early withdrawal penalty. For example, with an IRA, you can avoid the penalty if you use early withdrawals for the first-time purchase of a home, higher education expenses or health insurance premiums paid while unemployed. This may make an early withdrawal from an IRA a more flexible option for you, particularly if you find yourself unemployed.
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About the Author
After earning a B.A. in English with a Specialization in Business from UCLA, John Csiszar worked in the financial services industry as a registered representative for 18 years. Along the way, Csiszar earned both Certified Financial Planner and Registered Investment Adviser designations, in addition to being licensed as a life agent, while working for both a major Wall Street wirehouse and for his own investment advisory firm. During his time as an advisor, Csiszar managed over $100 million in client assets while providing individualized investment plans for hundreds of clients.