Many Americans are struggling during the COVID-19 crisis, and that includes the millions who have already lost their jobs. It's not surprising, then, to learn that 20% of people say they'll likely take a 401(k) withdrawal in the near term to put cash in their pockets, according to the May 2020 Simplywise Retirement Confidence Index. But that's a decision they might sorely regret.
The consequences of taking an early retirement plan withdrawal
Normally, tapping a 401(k) or IRA prior to age 59 1/2 results in a 10% penalty on the amount you remove. But thanks to the CARES Act passed in March, you can now withdraw up to $100,000 without penalty from a retirement plan if you can show you've been negatively impacted by COVID-19. That's a nice option to have in theory, because it's easier to remove money that's yours from a retirement plan than to go out and qualify for a loan. But taking an early retirement plan withdrawal is a bad idea for three big reasons.
1. Taking a withdrawal now could mean locking in losses
Most retirement plan values are down because of COVID-19's brutal stock market beating earlier this year. If you take a withdrawal now, you'll risk solidifying those losses, whereas if you leave your account alone and wait for the market to recover, you may not lose a dime.
2. The more money you remove now, the less you'll have for retirement
You may be desperate for cash at present, given the current situation. But think about what your financial circumstances might look like once you're in your 70s or 80s and you haven't worked in years. Chances are, you'll need all the money you can get at that point, and the more you remove from your 401(k) or IRA today, the less your senior self will have access to.
3. You'll lose out on investment growth on your money
The money in your 401(k) or IRA shouldn't just sit there doing nothing. Ideally, you should be investing it in a manner that lends to decent growth -- namely, by loading up on stocks. If you take a retirement plan withdrawal today, you'll lose out on whatever growth that money could have achieved. Now, imagine you take out $15,000 to pay some near-term bills, but you're 30 years away from retirement. If your retirement plan investments normally generate an average annual 7% return, which is a few percentage points below the stock market's average, you'll wind up losing out on $114,000. And that's a lot of money to give up.
You may feel you have no choice but to take a withdrawal from your retirement plan in the coming weeks or months. But before you do, explore other options. See if you can defer some bills, crank up your income with a remote side hustle, or borrow money affordably with a home equity loan. If you're truly out of options, you're better off removing funds from your 401(k) or IRA than racking up expensive debt, like that of the credit card variety, but if you can avoid an early withdrawal, you'll be better off later in life.