We have heard it so often; it’s become a cliché. Whether it’s a hurricane on the horizon, a global pandemic, or a meltdown in the markets, the experts always assure us: “This is not the time to panic.” But in the genuinely unprecedented emergency that we’re enduring now, it’s helpful to have some good advice on what we should do while we’re not panicking.
Our focus right now is on what to do if the economic crisis that’s followed the coronavirus crisis has left you in a cash-flow bind. For many people, retirement accounts are a tempting source of emergency money, but one that’s normally considered off limits. Now, however, financial reality may dictate a violation of that formerly ironclad rule: do not tap your retirement fund in an emergency.
Fortunately, part of the emergency legislation that Congress has recently passed provides some relief from the normal rules governing retirement account.
So here are some step-by-step suggestions about how to think through your need for short-term cash.
First: ask yourself, “How badly do I truly need this?” Remember that many entities, including banks, mortgage companies and utilities, are offering help to their customers. These may take the form of payment holidays, deferred interest, or the waiver of penalties for those who are temporarily out of work or have had to shut down their businesses. If you can postpone some regularly scheduled payments by a few months, it may be better to catch up later, when things return to normal, than to tap into your IRA or 401(k) now.
Second: if you truly do need cash now, and you have a taxable investment fund, it’s best to draw it from that source first, rather than deplete your retirement assets.
Third: If you do have to draw on retirement funds, don’t do so willy-nilly. It’s better to take money from a Roth IRA than a conventional IRA. And if you have a 401(k) or similar employer-sponsored plan, consider whether borrowing against your balance is a better option than simply selling off assets. (Borrowing is not an option for an IRA.)
So, let’s examine these points one at a time.
Maximum withdrawal: The “CARES Act” relaxes the rules on tapping retirement accounts, but only up to a $100,000 cap. If you take more than that, you will be subject to the old familiar tax and penalty rules.
Roth IRA first: If you have a Roth IRA, you have already paid income tax on that money, so any withdrawal won’t be subject to taxes now. In other words: get “post-tax” money before you tap into any “pre-tax” money.
No early withdrawal penalty: Whether it’s from a Roth or conventional IRA, premature withdrawals—if you are younger than 59 ½ years and are normally subject to a special 10 percent tax. That has been suspended for the time being.
To summarize: if you take less than $100,000, you will not pay any penalty. If it’s from a Roth IRA, you will not pay income tax, either.
Here is one other very welcome provision. While normally any money you put into your Roth IRA counts as a contribution (thus subject to tax), the emergency legislation has opened a three-year tax-free window, starting in 2021, during which you can repay anything you took out of that account—and not have it count as a new contribution. So, if you want to build that Roth IRA back up, replenishing what you have to withdraw this year, it will be as if you’d never taken it out—at least for tax purposes.
Should you decide to pay yourself back, that can be done in whole or in part; it can be done in installments or in a lump sum. And while this might not be the best strategy, it doesn’t have to be done at all.
Now for those whose retirement money is in an employer-sponsored plan, most commonly a 401(k): You may, depending on how the plan is set up, be able to borrow against your plan’s balance. And the CARES Act has raised the maximum loan amount to $100,000. (Sorry, IRA owners: borrowing is not an option for you.)
I won’t try to get into detail about how this all works, because each plan has its own rules for how to borrow against your assets. You’ll need to contact your company’s HR department or your plan’s administrator for details. One important detail that you should factor into your calculations is the interest rate you’ll be paying. Yes, you’re borrowing your own money. But because it’s no longer available to be invested on your behalf, you will have to pay interest on that loan. The good news: you’ll be paying that interest back to yourself.
In something of a parallel to the reinvestment provision for Roth IRA owners, the CARES Act has given 401(k) borrowers a five-year window in which to repay their loans. That begins in 2021.
In a worst-case scenario, your final option for accessing funds in an employer-sponsored plan is to take advantage of the new Hardship Withdrawal rules, mandated in the CARES Act. A “Coronavirus-Related Distribution” is defined by the bill as any distribution from an eligible retirement plan made on or after January 1st, 2020 and before December 31st, 2020 to an individual. A Coronavirus-Related Distribution qualifies for anyone who is diagnosed with the virus SARS-CoV-2 or Coronavirus 2019 (COVID-19) by a test approved by the Centers for Disease Control and Prevention. Qualifying Hardships also include any spouse or depended who has been diagnosed.
One final note: Everything up to this point has concerned those who aren’t yet taking regular distributions from their retirement accounts. For those who are retired, the good news is that job losses, business shutdowns and similar income shocks are less likely to be a problem. Your retirement income won’t be interrupted.
But there is one concern that’s familiar to anyone who has weathered previous market downturns. Whether IRA or 401(k), almost every retirement account has been hit, and will continue to be hit, by the drops and volatility in stocks and other equity investments. If you are concerned about depleting your investments when their value is depressed, it may be worth considering whether a temporary reduction in your monthly distributions is something you can manage.
The fewer dollars you draw from your assets when their value is depressed, the more will remain to gain value again when, as they always do, the markets rebound.
Managing assets and planning for a comfortable retirement are challenges at any time. Now, more than ever, making wise decisions without panicking is important for everyone. The investment and retirement-planning experts at Old North State Trust understand the ins and outs of the markets and of the regulations that govern retirement accounts. They can offer accurate, trustworthy guidance to help you get through troubled times.
Old North State Trust, LLC (ONST) periodically produces publications as a service to clients and friends. The information contained in these publications is intended to provide general information about issues related to trust, investment and estate related topics. Readers should be aware that the facts may vary depending upon individual circumstances. The information contained in these publications is intended solely for informational purposes, is proprietary to ONST and is not guaranteed to be accurate, complete or timely.