For different purposes, many 401(k) account holders seek to withdraw cash from their retirement plans to meet other pressing needs. While it is not advisable to take out of your retirement accounts, 401(k)s have a penalty fee for early withdrawal.
The current coronavirus pandemic presents a tangible reason for many to touch their 401(k) retirement accounts especially those with no other form of passive income or savings. As a result of this, the US Senate is putting into consideration the possibility of allowing 401(k) account holders to make a “hardship distributions” of up to $100,000.
The hardship withdrawal allows permits account holders to withdraw from their 401(k) accounts without the usual 10% penalty that applies to an early withdrawal of those below age 591/2. They will also be given three years to repay the amount taken out and the required taxes as income taxes still apply to the amount taken.
This move is part of the US government’s plan to stimulate the economy through a Covid-19 stimulus package alongside other economic stimulation packages. This also applies to individual retirement account (IRA) holders if approved.
In addition to the retirement account stimulus package, families would also suspend payroll taxes for employers and adults would be issued rebate checks of $1,200 and $500 per child.
Some experts are of the opinion that it is best not to touch out of your retirement account regardless of the situation that presents itself as there are future financial implications attached to it. Ed Slott, founder of Ed Slott & Co. warns people against this saying “people play up the relief like it’s a freebie.” It actually seems like a “freebie” but in reality “you’re better off using anything else before using your retirement savings.”
It is without a doubt that many retirement account holders would be in great need of the penalty-free hardship withdrawal especially those directly dealing with the coronavirus infection. Or those who experience financial hardship as a result of being quarantined.
It is therefore of utmost importance to count the costs of taking out of retirement accounts before proceeding with the decision, according to Slott.
The costs include the fact that the “hardship distributions” are still subject to taxes. Therefore, over the next couple of years after the pandemic passes away, account holders who take hardship withdrawals would pay double taxes over the next three years: the first being their regular income taxes and the second being the outstanding 401(k) taxes. Alongside making extra plans to repay the amount taken from their 401(k).
The only benefits account holders would get are emergency cash and no penalty charges. Everything else that is associated with the disadvantage of withdrawing from your 401(k) remains intact. Therefore, people who seek to proceed with “hardship distributions” if/when it gets approved would have to plan ahead of time to cover future tax bills and repayments and contributions.
Paul Poretta, partner at Pepper Hamilton LLP, New York warns that in addition to planning your finances and cash flow ahead of time to fit into repaying all outstanding debt from your retirement account over the course of three years, it would still be best to find out the 401(k) rules that apply to your workplace.
“A 401(k) plan or a 403(b) plan, even if it allows for hardship withdrawals, can require that the employee exhaust other sources of money before taking a withdrawal,” he said.