The Coronavirus Aid, Relief, and Economic Security (CARES) Act—federal legislation that was passed in March to provide relief to Americans struggling economically due to the coronavirus pandemic—offers an enticing option for withdrawing money from employee retirement accounts.====
Here are two ways that 401(k) holders who can show that they have been impacted by the coronavirus outbreak can access these accounts due to the CARES Act:
- Account holders can withdraw as much as $100,000 from their 401(k) accounts through the end of 2020. While they will be not be assessed the 10 percent early withdrawal fee that is typically applied to account holders ages 59½ and younger, they will have to pay taxes on the withdrawal over the course of three years.
- Account holders can also borrow up to $100,000 (double the typical $50,000 allowance) from their 401(k) until September 22 with their employer’s consent.
Some Americans are taking the government up on this offer, as many live paycheck to paycheck and have felt pressure to dip into their savings. The CARES Act took effect in late March, and since then, more than 370,000 people have withdrawn money from their retirement accounts, according to Fidelity. The average withdrawal was $13,000, but as many as 8,500 have borrowed the full $100,000 from their 401(k)s.
While this may seem like an effective stopgap measure during a difficult economic time, withdrawing money from your 401(k) early is not a decision to take lightly because it could significantly impact your long-term retirement plans. Here are some issues to think through before pulling money out of your 401(k).
The Long-Term Impact
Even if you pay yourself back after your economic situation improves, taking money out of your 401(k) early, even temporarily, will negatively impact your long-term savings.
Boston College’s Center for Retirement Research has determined that withdrawing money early from your 401(k) can reduce your retirement wealth by as much as one-fourth, according to a report from MSNBC. The reality was borne out during the economic downturn in the late 2000s, when people also made early withdrawals from their 401(k)s. By 2019, people who had sold their stock in 2008 had an average balance of $275,000 in their 401(k)s, while those who had not sold stock averaged $360,000 in retirement savings, according to Fidelity.
MSNBC offered the following example: A 60-year-old who earns $60,000 annually has contributed 9 percent of her earnings to her 401(k) annually for 30 years with an annual return of 6.5 percent. When she retires, she will have a savings of $675,000.
However, if she had withdrawn $40,000 when she was 40 years old due to hardship, her savings would be reduced to $480,000 at retirement.
Additionally, 401(k) balances are down across the board due to market declines. That means withdrawing money now will lock in losses, never giving that initial investment time to recover when the market improves.
Impact on the Workplace
In a recent Forbes survey on how the pandemic is affecting retirement planning, 11 percent of respondents said that they were planning to work longer to offset financial shortfalls. The majority of these individuals were 45 to 54 years old, while respondents aged 18 to 24 were the least likely to say they planned to extend their working years.
In some cases, longer working years may be attributed to changes in how employers are contributing to their employees’ 401(k) accounts. About 4 percent of respondents said their employers had stopped matching contributions during the pandemic—a number that could grow as pandemic shutdowns continue.
A Way Forward
If possible, financial advisors recommend staying calm during a crisis and focusing on long-term savings goals. historically, the ups and downs of the market tend to balance out over time. For example, between 2007 and 2012, 401(k) account balances grew an average of 12 percent annually, according to the Employee Benefit Research Institute. Reacting to market downturns by selling investments, decreasing contributions, and making early withdrawals can result in lower balances at retirement.
It’s particularly risky to borrow from your 401(k) at times of high unemployment (currently, 40 million people are out of work) because you are much more likely to be able to repay a loan when you have a job than when you don’t.
However, if you need to borrow from your 401(k) to pay bills during the pandemic, you do get a break on repayment. The CARES Act gives some borrowers a year before they must begin repayment. However, if you don’t repay the loan in five years, it will be considered a withdrawal, complete with a 10 percent penalty plus tax.
If you can stay the course, keep making monthly contributions to your 401(k) and, if possible, make additional contributions. Since so many businesses and entertainment venues are closed, Americans are spending less and saving more, making this a great time to put some of that extra money into retirement savings.