Over the last year, we’ve had to change how we do a lot of things. We’re working differently… seeing friends differently… even our family gatherings look different now. The holidays were unlike any we’ve had in our lifetimes. Fewer table settings. Fewer last-minute trips to the grocery. And now, we’re seeing that it’s affecting retirement planning.
Some may have lost their jobs and are looking to their retirement funds as a way to make ends meet. Others may be worried about the market and are now looking to have more cash on hand just in case they need it.
It’s tempting to use retirement dollars to make it through a time of uncertainty (especially with special rules allowing penalty-free withdrawals up to $100,000). But it that the best way to plan for the future?
Let’s check out a few ways you could access money you have set aside for your retirement years, and look closely at the pros, the cons, and the ways that could affect you this tax season.
Stopping Retirement Contributions
One way that people may look to increase the cash they have in hand is to stop making contributions to their retirement accounts. This may mean reducing the actual amount of pre-tax dollars coming out of their check into their 401(k).
While this may be tempting (and could be better solution than actually taking money out of your retirement account), remember that you’re still taking money away from your long-term savings for a short-term situation.
Because of compounding interest, this could be a bigger loss than it may seem immediately. And if your employer matches part of your contributions, you’ll be missing out on this benefit.
Plus, since a 401(k) and IRA are tax advantaged, you may actually increase your gross taxable income for the year if you reduce your contributions. This may be something to think about, as it could affect your taxes for the year.
Using Your IRA or 401(k) Savings
You may be able to leverage your retirement account (think 401(k) or IRA) to get money you can use now for bills, groceries, and other necessities. There are a couple different ways to use that money—but think carefully before you withdraw, Even though the CARES Act has removed some barriers to using that money, using those dollars may have long term effects on your retirement investments.
It’s usually never a good idea to withdraw from your retirement account, because of the 10 percent early withdrawal penalty. But because of COVID-19, Congress wrote the CARES Act that waived this penalty (on up to $100k of retirement funds) if you qualify. This means if you or a spouse or dependent tested positive, or you lost your job because of COVID, you could use those retirement funds to pay your bills. There is now a second round of stimulus: the Coronavirus Response and Relief Supplemental Appropriations Act of 2021. This includes several “tax extenders”, that means the penalty will continue to be waived for now.
Now, this means you could withdraw that money with no penalty. But you will still have to pay taxes on that money, just as you would if withdrawing it in retirement. Luckily, the CARES Act allows the borrower to pay the taxes on the withdrawal over three years, rather than all at once, but this will still be something to consider when filing your taxes. You can also pay back the amount you withdrew and claim a tax refund.
And while Roth IRAs are often free from tax and penalties, it’s still considered an unqualified withdrawal if the account was converted from a traditional IRA within the last five years.
Often, even without a penalty, it doesn’t make financial sense to withdraw money from an IRA, 401(k), or even a Roth account early. Every dollar you take from a retirement account affects your compounding interest, reducing the amount you’ll have in retirement. You could be missing out on substantial growth over the long-term.
Some personal finance blogs offer a useful calculators for figuring out your unique 401(k) situation, like this one.
Taking Out Loans
Many people are also able to take out loans against the balance in their retirement accounts. You can now take out a loan of up to $100k thanks to the CARES Act. This may be a better option than withdrawing if you feel confident you can pay the money back.
It will ensure your investment keeps earning for you, while still putting cash into your hand.
If you know you can pay the money back, then a loan may be a better option for using retirement dollars to work for you immediately.
This way, your investment keeps earning returns, and you still have cash on hand to use. And as long as you meet the rules of repayment, this loan won’t cause you to pay more taxes in retirement.
Using Your Stocks
You may have decided to invest in stocks yourself, independent of your retirement accounts. These could be another way to find money in an economic downturn.
Obviously selling stocks is the way to generate immediate cash you can access. And many people panic-sell when things get bad. Either to liquidate so they have cash, or simply because they fear the market taking down their investments. But generally, the market rises and falls through the years. The market has historically produced returns of around 10% annually for the last hundred years.1 While there are never any guarantees with stocks, the evidence suggests things will return positively as the market corrects.
In the 2008 crash, financial advisors watched and learned. Investors who kept their money in the diversified portion of their investment portfolios did better than those who sold when things got turbulent. It’s nearly impossible for an average investor to predict the best times to buy and sell. So the general advice is to leave things alone, give the market time to rebound, and hope the trend of consistently average annual returns continues.
If you’re looking for cash-in-hand right now, buying may not be the direction to go. But if you’re looking to increase your earnings, the market may be a good place to look.
When the market (and economy as a whole) are down, it could be the better time to buy stock. You could think of it as a sale—we expect the market to return, so the low stock prices could rise as the market corrects. If you have the money to invest, it may be profitable in the long term.
Different Filings for Different Situations
If you’re looking for immediate cash, you may be reducing your contributions (increasing your taxable income), withdrawing from your IRA (creating a new tax situation), or selling some stock (which you’ll pay taxes on).
This might not just impact your taxes this year—some of those decisions could impact you in years to come.
While we’re the experts on retirement planning, we partnered with the experts at TurboTax to learn about ways to maximize benefits and reduce the tax burden.
And right now, you can get $20 off when you file your taxes with TurboTax! Their software walks you through your specific situation, asking the right questions to help you navigate taxes as you make a few changes to adjust in this economic downturn.
If you’re looking to make adjustments to your retirement planning, a Washington National representative can help you make adjustments in your retirement planning.