Withdraw from Your Retirement Funds Due to Coronavirus or Continue to Save?
The Coronavirus pandemic has caused Americans all over the country to feel various financial impacts. These have been especially tough times for people who have already lost their jobs or working fewer hours, and for those who may face the uncertainty of unemployment in the coming weeks or months. Many have drained their savings, and some have looked to their retirement funds for early withdrawals as a way to stay above water. However, this may not be the best way to stay afloat.The Situation
In mid-March, the U.S. declared a national emergency, and shortly thereafter, many states issued sheltering in place orders. Many businesses with a physical location were closed. While a certain percentage of workers were able to shift to virtual work, a large number were laid-off, and millions of people have filed for unemployment. Some business owners are unsure if they will be able to keep their doors open.
The U.S. stock market plunged as businesses closed, erasing virtually all the gains of the last several years. Although the stock market has showed signs of improving, it remains down from the start of 2020.
Before you make a financial decision that may help in the short-term, it’s important to look at the long-term effects this quick-fix may have. For example, should you draw from your retirement funds due to the Coronavirus? Or should you continue to save?
Continuing to Save
Tapping into retirement funds can be a tempting option, especially if you’re unemployed right now. The spike in the volume of unemployment claims is causing a delay for many states in providing relief. For many, it can be tough to wait it out.
The prudent approach, though, is continuing to save for several reasons. The first, and primary, reason is potential loss of capital appreciation if you withdraw funds now. While the Coronavirus has certainly dampened the stock market significantly this year, stocks historically rebound, even from very dismal years.
In the Great Recession year of 2008, for example, the S&P 500 fell significantly. But in the following years, prices rose without another bear market through 2019. People who kept their retirement funds in stocks through that period saw handsome, and even record, gains.
No one can predict when the rebound after the Coronavirus will begin. But if you withdraw funds, and another significant stock market climb begins, your money is no longer invested. You won’t be able to benefit from the advance.
Plus, it’s impossible to time the market, and most people don’t put money back in time to catch the rising tide.
If your retirement funds are invested in cash instruments or bonds, the same is also true; you can miss out on any interest.
If your retirement funds are invested in stocks with dividends and you have the dividends reinvested, you will miss out on the shares purchased by those reinvested dividends.
Appreciation and reinvestment over the years can power your nest-egg growth. If you withdraw funds, you may have given all that up.
Taxes and Penalties
It’s important to remember that early withdrawals from retirement funds, such as 401(k)s and traditional Individual Retirement Accounts (IRAs), are eroded by taxes and penalties.
The amount of taxes withdrawn depends on your tax bracket.
The recently passed Coronavirus Aid, Relief, and Economic Security (CARES) Act does offer help in dealing with tax payments on early withdrawals. The Act gives qualifying individuals three years to pay the tax (which is not usually the case). You can also, within certain guidelines, pay the withdrawn amount back into a retirement account and avoid the tax. But if you don’t, you'll incur the tax bill.
Generally, people who withdraw from retirement funds before age 59-½ are also subject to a penalty of 10 percent of the withdrawal amount.
Once again, the CARES Act does provide some relief. The Act eliminates penalties for withdrawals due to the Coronavirus. However, this is only the case for certain groups of people who withdraw within certain dates.
Penalty-free withdrawals and tax relief are provided for those who have tested positive for the virus, or whose spouses or dependents have tested positive. They are also allowed for those who experienced “adverse financial consequences” as a result of being quarantined, furloughed or laid-off; having work hours reduced due to the virus; being unable to work due to lack of childcare because of the virus; being forced to close or reduce hours of a business owned or operated by the individual because of the virus; or other factors as determined by the Secretary of the Treasury (or the Secretary’s delegate).
If you don’t fall into one of those categories, the 10 percent penalty still applies.
Withdrawals for eligible individuals are capped at a total of $100,000 per individual. They must be made between March 27, 2020 and December 31, 2020.
“But what if it’s simply necessary to access cash quickly in this period?” some have asked. That’s understandable, but because of the potential loss of appreciation, taxes and perhaps a penalty, methods of accessing cash that don’t carry these negatives might be a better method.
You will want to discuss your options with a financial advisor to see what makes the best sense for your specific situation. If you’re not currently working with a financial advisor or would like some proactive retirement education and planning from a second source, contact Linscomb & Williams. We’re here for you, whether you’re a current client or not.
Potential alternatives include:
- Utilizing your stimulus check. A stimulus check for $1,200 is coming to any American whose Adjusted Gross Income (AGI) on their tax return is less than $75,000. If your AGI is higher than that, the amount is reduced $5 for every $100 in income above $75,000, up to $99,000, at which point people are no longer eligible for the stimulus check. Families will also receive $500 for each dependent child.
- Filing for unemployment benefits. If you are unemployed due to the Coronavirus, the CARES Act also enhanced unemployment benefits. Pandemic Unemployment Assistance is slated to pay $600 per week on top of your state unemployment benefits. For the first time ever, unemployment benefits also cover unsalaried workers (such as the self-employed, freelancers and contractors) who normally aren’t qualified for unemployment. They should receive the $600 and a percentage of the average unemployment benefit from the state.
- Tapping emergency funds. Emergency funds, recommended at three to six months’ worth of your income, should be part of your financial plan. The Coronavirus and its effects definitely qualify as an emergency.
Talking to a financial advisor about your situation now is more important than ever to safeguard your present and your future. Proactive retirement education and planning could be the game-changer.