The CARES Act makes it possible for consumers to take up to $100,000 from their 401(k) or 403(b) retirement plans with no penalty. And, although it is taxable, they can pay the taxes over three years. The normal 20% withholding is waived as well. The legislation passed because many people are facing significant financial challenges due to the COVID 19 pandemic. The question for many consumers is, should I use retirement savings to pay for emergencies?
For some people, the answer is obvious. If you experience long-term unemployment that will outlast your emergency savings, you should consider withdrawing enough to pay your required expenses until your income returns. However, if you still have a consistent income and are able to continue paying all your regular expenses, you should not make a withdrawal.
What if My Finances Are in a Gray Area?
Unfortunately, many situations are not quite so clear, and consumers would like to better understand the consequences. It always sounds good to get an extra $10,000 or $50,000 or even $100,000 in cash. It is a chance to get current on bills, or buy a vehicle, or make a down payment on a house. Why not just do it? Let’s take a look at an example.
$100,000 in a retirement account earning 3.6% annually would grow to $202,859 in 20 years. A 46-year-old consumer should see that $100,000 as $202,859 to spend in retirement. That would amount to almost $20,000 a year for the typical American. Since the average Social Security benefit is $18,036 a year, that $20,000 could easily be the largest source of income for that person.
Do I Have Enough Time to Save?
Many people find it difficult to compare the benefit of income at age 66 with the benefit of immediate cash. Psychologists refer to this as discounting your future self. We think that the older person we will become is not as important as the person we are today. Be assured though, that some day that outlook will change and that senior citizen you will become will want to feel secure.
The circumstances and the impact of a withdrawal do change based on age. After age 50 it will be much more challenging to save enough to help you in retirement. A 50-year-old consumer wanting to replace the $202,859 loss from a withdrawal would need to save $785 a month until age 66; not a reasonable goal for most of us. But a younger person might well be able to do this since time is such a critical factor. A 35-year-old could recover by saving an extra $300 a month until retirement.
What’s the Bottom Line?
The answer then, is make a withdrawal from retirement savings if you must to pay your basic expenses. Take as little as you possibly can and be more cautious if you are older. If you’re under age 30 you’ll have plenty of time to recover those funds. If you’re over age 55, taking a withdrawal can mean your retirement plans will need to be adjusted.
Tell Me What’s Next.
Once consumers understand the real cost of a withdrawal from retirement savings, they need to create a strategy to recover. If they decide to withdraw a significant sum from retirement plans, they need a different plan for living during their senior years. It might involve a new investment plan or a new career plan that at least offers the hope of working past normal retirement age. Consumers should strive to pay off a mortgage and eliminate all other debt before retirement and keep healthcare costs in mind, which tend to become a major expense in later years.