COVID-19 has already hurt a lot of Americans financially, and with cases still popping up by the thousands, it's clear that life may need to stay on hold longer than we'd like it to. That's bad news from an economic standpoint, because the longer businesses stay closed and Americans remain out of work, the harder our recovery will be.
Thankfully, there's some relief to be had in the form of the CARES (Coronavirus Aid, Relief, and Economic Security) Act -- namely, one-time $1,200 stimulus payments that have already started going out to desperate Americans, boosts in unemployment benefits, small business funding, and more relaxed rules with regard to retirement plan withdrawals.
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Normally, removing money from an IRA or 401(k) prior to age 59 1/2 results in a 10% early withdrawal penalty (though there are some exceptions). Under the CARES Act, however, you can now withdraw up to $100,000 from your retirement plan penalty-free if you've been negatively affected by COVID-19. But here are three reasons it's unwise to go that route.
1. You'll lose out on more than just your principal contribution
You're no doubt aware that any money you remove from your IRA or 401(k) today is money you won't have on hand once retirement rolls around. But you may be surprised at how a seemingly modest withdrawal results in a much greater loss over time.
The money you have in a retirement plan generally doesn't just sit in cash. Rather, it's invested for added growth. And if you load up on stocks in your IRA or 401(k), you're likely to generate an average annual 7% return over time, since that's a few percentage points below the market's average.
Now, let's say you withdraw $10,000 from your retirement plan today to pay some near-term bills. If you're 35 years away from leaving the workforce, you'll actually end up losing out on almost $107,000 in retirement income when we factor in that 7% return. And that's a lot of money to give up.
2. You may have affordable borrowing options at your disposal
Being in debt isn't fun, and in some cases, it can be costly. But before you raid your retirement plan, it does pay to explore the low-cost borrowing options you may be privy to.
If you own a home you have equity in, a home equity loan or line of credit is fairly easy to qualify for, and you generally won't be charged an exorbitant amount of interest on either. If you don't own a home, you can look at getting a personal loan -- a viable option if your credit is strong.
All of these options allow you to use your loan proceeds for any purpose, and they're worth looking into if you're struggling. And in many cases, the interest you pay on one of these loans will be less than the return your retirement plan generates.
3. You may get a reprieve on paying a lot of your bills
If your income has taken a hit in the past month and change, you may be having a hard time keeping up with your bills. But before you withdraw money from your retirement savings to cover them, talk to the people you owe money to and ask for some leeway. Your mortgage lender may agree to let you put your home loan into forbearance for a period of time, thereby effectively pausing payments on it. Meanwhile, you may be given more time to pay your auto loan, internet bill, or electric company. It never hurts to reach out and ask for help, and doing so could help you avoid an early retirement plan withdrawal -- or perhaps enable you to remove less money than you initially planned on.
Let's be clear: If you really have no choice but to remove money from your IRA or 401(k) to pay for your basic needs, then there's no need to beat yourself up for it. Many people have been thrust into a desperate situation because of COVID-19, which is why penalty-free withdrawals are now on the table. But before you rush to take that withdrawal, recognize the drawbacks of going that route, and explore other options for borrowing money affordably while getting relief from your bills.
