Ever since U.S. cases of COVID-19 started multiplying back in March, the economy has been in shambles. Millions of workers have lost their jobs, while countless small businesses have closed their doors, perhaps forever.
With so many people desperate for money, it's clear that a relief package was necessary, and so in March, lawmakers passed the CARES Act. Perhaps the most popular feature of the CARES Act was the $1,200 stimulus payment it produced, but another notable feature is the option to withdraw from a 401(k) or IRA without penalty if you've been impacted by the pandemic. Normally, withdrawing funds from a 401(k) or IRA prior to age 59 1/2 results in a 10% penalty on the sum that's removed, but under the CARES Act, that penalty is waived provided you can prove you've been hurt by COVID-19 and your withdrawal is limited to $100,000.
It's an option that a large number of Americans are contemplating. In fact, in a new Transamerica survey, 22% of workers have either tapped a retirement plan for money already, or are planning to do so.
Millennials, in fact, are the most likely to raid a retirement plan to access money in a pinch, with 33% saying they've gone that route already or plan to do so. In contrast, only 15% of Gen Xers and 10% of baby boomers say the same. But no matter your age, withdrawing from your retirement savings prematurely is a move that could wreck your golden years, and it's one you should only consider once you've exhausted all other possibilities.
The problem with taking an early retirement plan withdrawal
If you're desperate for money right now and have some sitting in a 401(k) or IRA, raiding that account might seem like a good solution. But doing so is a bad idea for a number of reasons.
First, if you remove funds from a retirement plan when your account value is down, you risk locking in losses on your investments. Secondly, the more money you take out of your plan today, the less you'll have available once your senior years roll around. Third, when you take an early retirement plan withdrawal, you don't just lose out on the principal sum you remove; you also lose out on investment growth.
Imagine you're 25 years away from retirement and you take a $15,000 IRA withdrawal to cover some near-term expenses. If your investments in that IRA normally deliver a 7% average annual return (which is a few percentage points below the stock market's average), then you'll actually end up $81,400 shy by the time retirement rolls around. That's a far more substantial hit than you may be prepared for.
It's for these reasons that tapping your retirement plan should really be your last resort. If you have emergency savings, deplete them first. Along these lines, explore options for borrowing money affordably. While you shouldn't go out and rack up a ton of credit card debt when you have funds in a retirement plan you can access, you may be able to snag a low-interest home equity or personal loan that tides you over until economic conditions improve. The fact that it's possible to take a penalty-free 401(k) or IRA withdrawal right now is technically a good thing, but make sure you've explored all other possibilities before removing money you might desperately need later in life.