Millions of Americans are out of work indefinitely due to COVID-19, and that has a lot of people scrambling to figure out how to provide for their families until life returns to normal. Unemployment claims have already shattered records, and the passage of the Coronavirus Aid, Relief, and Economic Security (CARES) Act has extended unemployment eligibility while also promising stimulus checks to millions. 

The act has also made it easier for Americans to tap their retirement savings without paying taxes or penalties, but that doesn't mean it's a good idea. There are a few things you need to consider before cracking your nest egg open.

Man at laptop reading documents

Image source: Getty Images.

Not everyone qualifies for penalty-free withdrawals

The new bill removes the 10% early withdrawal penalty and enables you to withdraw up to $100,000 for a COVID-19 distribution, but only if you meet at least one of the following criteria:

  • You, your spouse, or a dependent has been diagnosed with COVID-19.
  • You're experiencing financial hardship because you've had your working hours reduced or you've been quarantined, furloughed, or laid off due to COVID-19.
  • You're unable to work because you must care for a child who cannot attend school due to COVID-19.
  • You're a business owner who has had to reduce your hours or close due to COVID-19.

If you make a withdrawal for some other reason, your distributions are technically still subject to an early withdrawal penalty. 

You'll still owe taxes on tax-deferred retirement distributions

Even if you don't have to pay a penalty, you'll still owe taxes on your retirement distributions, unless that money comes from a Roth account or you pay it back within the allotted time. The CARES Act gives people up to three years from the date of their initial withdrawal to put their IRA or 401(k) distributions back without paying taxes on them. If you choose to go with a 401(k) loan instead, you may have up to five years to pay back what you owe, plus interest. Check with your 401(k) plan administrator to see if this is an option for you.

You can withdraw up to $100,000 from your retirement accounts, and you don't have to do this all at once. Every withdrawal starts a new countdown. You must put back all the money you borrowed before the deadline, though distributions don't necessarily have to go back into the same retirement account it came out of. You could take a distribution from your 401(k), for example, and then put it into an IRA if you choose. But if you take a 401(k) loan, that money must go back into your 401(k).

If you can't pay everything back by the deadline, the outstanding amount is considered a distribution, and it gets added to your taxable income for the year, which will raise your tax bill. It may even push you into a higher tax bracket, where you'll lose a larger percentage of your income to the government. So you should only tap your retirement savings if you're confident you can pay it back by the deadline, and even then, only borrow as much as you need.

You could be hurting the growth of your retirement savings

The stock market has taken a steep dive since the COVID-19 pandemic began. This means that most people's retirement savings today aren't worth what they were even three months ago. Withdrawing $1,000 from your retirement account before everything went south would've required selling off a smaller portion of your assets than it would today. 

It's possible that you might end up selling at a loss, and if you are unable to put the amount you withdrew back in the account by the deadline, your savings will take much longer to recover. It's difficult for many people to save enough money for retirement at the best of times, so you should avoid withdrawing money from your retirement accounts at all costs.

Alternatives if you need some extra cash

Before you tap your retirement savings, you should explore all of your other options. If you're not able to work, you may be eligible for unemployment. Under the new, expanded unemployment, individuals will receive an extra $600 per week during the COVID-19 pandemic. The CARES Act also includes a provision to send $1,200 stimulus checks to individuals who make less than $75,000 and $2,400 checks to married couples who make less than $150,000. 

Banks, credit card issuers, utility companies, and other service providers are also creating or expanding hardship assistance programs to help those affected by COVID-19. These programs may enable you to defer some payments penalty-free, allowing you to use what cash you do have to go a little further.

It's nice having easy access to your retirement savings if you have nowhere else to turn to, but make sure you've exhausted all your other options before falling back on your retirement accounts.