To Tap or Not to Tap Your Retirement Savings?

It’s tough times out there for many Americans. We’re seeing record numbers of people filing for unemployment. For those who have lost jobs, it can be scary to think about where the finances will come from to continue paying things such as rent, mortgages, grocery bills, etc. Thus, during these times, it can be tempting to tap into retirement savings, especially if you have managed to build up a decent-sized nest egg. While I strongly, strongly discourage you from using your retirement savings to get you through these tough times, I realize that it may really be the only option for some. If you find that you absolutely are certain you will need to take some money out of your nest egg to get you through a jobless period, there are some new provisions in the CARES Act recently passed by Congress that can help you. First off, Congress has increased the amount you can take out of your employer-sponsored 401(k), if you have one. The limit used to be $50,000, but they have temporarily expanded it to $100,000 and will allow you to suspend payments on repayment for up to one year. It also allows for the terms of the loan to be stretched from five to six years. Again, this is all temporary under the CARES Act. Another important provision of the recent legislation is that it allows you to take a distribution from other retirement accounts you have without having to worry about the 10% penalty if you are under 59-and-a-half. It should be noted that there is a limit to the size of the distribution and that is $100,000. Now, again, I am not encouraging you to hit up your retirement savings immediately when trying to get through a period of unemployment. Rather, I’m sharing these two important provisions with you so that you are aware of the possibilities to get through tough times. Of course, if you feel that you need to tap into your retirement savings, you should consult with a retirement professional or financial advisor to make sure it’s the right decision and that you understand what you are about to do.

Retirement Accounts and Government Coronavirus Relief

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law on March 27. It’s a massive relief package designed to help Americans get through these difficult economic and financial times. Yes, this is the legislation that also includes the one-time payments from the government for those below a certain annual salary. While most of the reporting on the CARES Act tends to focus on helping those of working age who find themselves without a job, it does have some advantages for retirees. First off, many retirees will be eligible to receive the highlight of the legislation–those one-time government checks that everyone keeps talking about. The CARES Act does allow for those collecting Social Security and other benefits–such as Supplemental Security Income–are eligible to receive a check. Now, obviously, this won’t apply to everyone and some seniors will not qualify due to their individual situations. You will need to submit a tax return for the government to determine if you are eligible, even if you know you won’t owe any taxes. Another interesting aspect of the act is that it is waiving required minimum distributions (RMDs) for 2020. That goes for both employer plans and IRAs. That means you do not have to take an RMD for 2020, if you are eligible to do so. This unprecedented waiver means that money stays in your retirement account. The CARES Act also waives the 10% early distribution hit you may take if you take an early distribution of up to $100,000 from an IRA or other retirement plans to cover costs related to Coronavirus. I don’t know the specifics of this yet and you will want to do some research of what qualifies before trying to take advantage of this. Of course, I also discourage you from taking money out of your retirement savings any sooner than you have to. However, I understand that situations, such as a costly illness, may change those plans. You may want to talk with a certified financial planner or wealth manager to learn more about your options and whether you can hypothetically do an early distribution. There’s a lot in the CARES Act legislation and I encourage you to read more about it and learn as much as you can, regardless of whether you are retired, near retirement, or decades away as it has the potential to impact a wide array of Americans.

Don’t Be Someone Who Hits Your Retirement Account Too Early

According to a recent study by the Treasury Department and the Joint Commission on Taxation, for every dollar that Americans under the age of 47 save for retirement, they withdraw 20 cents before reaching age 55. That may not sound like much, but that a fifth of a dollar. Furthermore, a 2019 report by the Government Accountability Office found that Americans during their prime working years withdrew almost $70 billion annually from retirement accounts–that is, before they reach retirement age. That’s a lot of money. I get it though, that retirement money can be tempting, especially if times are a bit tough. As the studies point out, many people don’t have the self control necessary to avoid tapping into their retirement accounts early. However, I strongly urge you to not be one of the people that fits within those studies and taps your retirement accounts too early. Ideally, you have some sort of emergency fund or financial plans to cover an emergency. I understand, though, that life can be unpredictable and an emergency can be costly, especially a medical emergency. Thus, tapping into your retirement savings should be an absolute last resort. Furthermore, there are penalties associated with early withdrawals if they do not fit within certain exceptions, which is even more of an incentive to not touch your retirement savings before you absolutely need to. If you need help with planning for a potential emergency or you want to avoid tapping into your retirement savings too early, you should speak with a certified financial planner or wealth manager.

Make Sure You Understand Early Distribution Exceptions

Thinking about taking an early distribution from your retirement plan and believe you can do so without getting hit with a penalty? You should be very, very careful in doing so. Yes, there are times when taking an early distribution is appropriate and you can avoid an early distribution penalty, but such situations are often few and far between. Aside from avoiding early distributions at all costs, you should really speak with a certified financial planner or retirement expert as part of the consideration process if you are fairly serious about doing so. While there are a number of ways you can take an early distribution without getting hit with a dreaded 10% penalty, it is also pretty easy to end up afoul of those exceptions and end up paying a hefty sum. The rules can be complex and if you don’t have a deep knowledge of how they work then you could be setting yourself up for trouble. This is why you need to speak with a financial professional who knows the rules and can provide honest and straight-forward feedback as well as make sure that you follow the proper rules should you find yourself in a situation in which you can take a distribution without the penalty hit. Those penalties can be somewhat hefty, especially if your distribution is a large chunk of money. Obviously you want to avoid the early distribution if possible, but if you do need to make one, be sure that you do so with all the knowledge and understanding possible.

Taking Advantage of the IRA Sweet Spot

Did you know that if you are between ages 59½ and 70½, you can take an early distribution from your IRA and not have to worry about the 10% early distribution penalty? You can take a distribution for any reason at all during this “sweet spot” period and not have to worry about getting penalized. You can also choose to not take a distribution during that time period as well since required minimum distributions (RMDs) don’t kick in until after you reach age 70½. Thus, this period offers the most flexibility regarding your IRA and associated retirement money. However, there is one caveat, you will still have to pay taxes on your withdrawal, unless it contains after-tax funds (which is rare). This period of IRA flexibility is also a good time to consider converting a traditional IRA–if you have one–to a Roth IRA as tax rates are currently low and you are not required to take RMDs from a Roth IRA during your lifetime. If you are considering either taking an early distribution from your IRA or converting a traditional IRA to a Roth IRA during that age 59½ to 70½ period, you will most likely want to speak with a certified financial planner so as to ensure that you are making a decision that is right for you.

Roth IRA Distribution Under Age 59.5

If you are considering taking money out of your Roth IRA before reaching age 59½, you will need to understand the Roth IRA distribution rules. The rules require that all contributions come out first and are tax and penalty free. Next comes conversion amounts. Contributions on distributed on a “first in, first out” basis and they are income tax free. However, any conversion taken out before reaching the 5-year holding period gets hit with a 10% early distribution penalty, barring any other exceptions. Once a conversion has been held for 5 years, it is not subject to that 10% early distribution fee. After you have taken out the basis, which the Roth IRA owner always has access to, the Roth IRA then distributes the earnings, which are always taxable and always subject to the 10% penalty if taking the distribution before age 59½. If you are considering taking a distribution from your Roth IRA before age 59½, you should speak with a certified financial planner or retirement expert to make sure you are doing so in a manner that limits penalties and will not hurt your savings.