COVID-19 is already battering the stock market and U.S. economy, and millions of Americans are already reportedly out of work. If you're in that boat, your first move should be to apply for unemployment benefits, though some workers, including those who are self-employed, may not be eligible. But even if your unemployment benefits start rolling in fairly quickly, they'll generally replace less than half of your wages, and that's if you're a low or moderate earner. If you're a higher earner, they'll replace an even smaller percentage. And if you don't have emergency savings, your options for paying the bills may be limited.
If this sounds like the situation you're in, you may be tempted to take a withdrawal from your 401(k) or IRA to cover your bills in the near term. But is that really a good idea?
Be careful with early retirement plan withdrawals
The IRS gives you a tax break for funding a 401(k) or IRA, and as such, you're expected to leave that money alone for its intended purpose: retirement. If you remove funds from either account prior to age 59 1/2, you'll face an early withdrawal penalty equal to 10% of the amount you remove. Furthermore, if you take an early withdrawal from a traditional retirement plan, as opposed to a Roth, you'll pay taxes on your distribution.
Now there are some exceptions that allow you to remove funds from a retirement plan without facing a penalty, but job loss, unfortunately, isn't one of them. Or at least not yet. Senate Republicans recently unveiled an economic relief package in response to the COVID-19 outbreak, and one of its provisions involves waiving the 10% early withdrawal penalty for savers who remove up to $100,000 from a retirement plan because of coronavirus-related reasons -- including job loss. But so far, that relief package has not been approved.
As such, it really pays to leave your retirement savings alone despite the financial hardships you may be facing today. Not only will doing so ensure that you avoid penalties, but it'll also ensure that that money remains earmarked for its initial purpose -- retirement. Remember, when you take an early retirement plan withdrawal, you don't just lose out on the principal amount you remove; you also lose out on growth on that sum.
Here's what that means: If you withdraw $10,000 today, at age 47, to pay your living costs for the next few months, you retire at 67, and you have a 401(k) or IRA portfolio generating an average annual 7% return (which is typically what you'll get when you load up on stocks), you'll actually end up losing out on nearly $39,000 of retirement income. And remember, you'll also risk losing $1,000 of that $10,000 off the bat in penalty form.
That's why it really pays to explore other options for paying your bills if you're temporarily out of work. In the absence of an emergency fund, a home equity loan or line of credit could be an affordable way to borrow money for essentials. Also, keep in mind that a lot of loan servicers and service providers are stepping up and offering relief to customers impacted by COVID-19. If you can't pay your mortgage, auto loan, or utility bills because of lost wages, reach out and see what options are available to you. There's a good chance you'll be able to defer some of those bills temporarily so that you don't have to resort to tapping your retirement savings and regretting it after the fact.