As unemployment claims skyrocket, Americans facing joblessness are rejiggering their personal finances, including what to do with their employer-sponsored retirement accounts.
While conventional wisdom says that people shouldn’t touch their retirement savings and instead let it grow over the long term, that calculus changes when faced with an immediate financial crisis – such as job loss from the coronavirus pandemic.
“We’re getting so many clients who are interested in early withdrawals,” said Whitney Morrison, director of financial advisory at LegalZoom, an online legal technology company. “This is the first time we’ve had to deal with this since 2008 and 2009.”
Here’s what to do if you need cash from your retirement account and if you don’t.
Getting cash out
When you’re unemployed, you can’t borrow against your 401(k); you can only withdraw funds. With the passage of the $2 trillion stimulus package, you can now take out $100,000 from either your 401(k) or IRA without having to pay the additional 10% tax penalty if you experienced financial hardships because of the COVID-19.
This doesn’t mean you have to be diagnosed with the virus. If you lost a job or income due to measures taken to slow the outbreak or if you have to stay home with a child because schools have shut down, those hardships qualify as well.
Previously, you were only excused from this 10% penalty, if you took money out for specific reasons the IRS highlighted or were 59 ½ or older.
Under the new legislation, you also can avoid paying taxes on the withdrawal as long as you return the full hardship amount within three years. If you can’t, you can spread out your tax obligation over the next three years starting this year.
Also if you’re 55 and older and lose your job, you can start taking distributions from that employer-sponsored retirement account without incurring a 10% withdrawal penalty. For public safety workers, that exception starts at age 50.
Roll over first, then withdraw
If you need funds to pay for education expenses, unreimbursed medical expenses, or pay health insurance premiums while unemployed, then an IRA conversion may be a smart option for you, said Colleen Jaconetti, a senior specialist in Vanguard’s institutional investor group.
“Roll it over it an IRA and you can take out money without the 10% penalty,” for those reasons, she said. That’s not the case for 401(k)s, which have fewer exceptions to the tax penalty than IRAs.
Keeping your cash
Roll over to avoid costs
Management fees for IRAs tend to be less than 401(k)s, so that’s a smart reason to roll over even if you don’t plan to withdraw any money.
“There are a variety of different fees that IRAs do not charge like a 401(k),” Morrison said. “It can be a good idea to roll over your 401(k) and give yourself some more room to generate returns or prevent more losses.”
You also get more control over your investment options. That can give you greater control during these volatile times, said Amit Chopra, managing partner at Forefront Wealth Planning and Asset Management.He said 401(k)s generally offer exchange-traded funds and mutual funds, which can limit you to a particular sector.
“You want control over what you’re owning at this time. You don’t want a big basket of stocks inside a particular industry such as consumer discretionary,” Chopra said. “Disney, for instance, is lumped with Carnival cruises and I would say Carnival cruises are going to recover slower than Disney due to recent behavior shifts.”
Another benefit with rolling over to an IRA is that you can eventually convert it to a Roth IRA regardless of how much money you make. Called a backdoor IRA, this allows your money to grow tax-free. If you need to withdraw funds later, you can withdraw without any penalty or income taxes as long as the funds were invested for five years.