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You should weigh up all the pros and cons considering 401(k) withdrawal or loan. Besides, it is better to first look into other options that wouldn’t reduce your retirement savings. If there are no, then think carefully about the amount you will need.
To balance your finances that may have suffered in the COVID-19 crisis, you may consider using a 401(k) plan. Here we’ll cover two options 401(k) account offers — borrowing and withdrawal — and see how both can impact your balance while helping to handle COVID-19 consequences.
According to a recent report from Principal Financial Group, the sum of the 401(k) plan depends on a number of factors. They include your age, continuing, reduction or suspension of your contributions, and whether it’s a loan or withdrawal.
Heather Winston, assistant director of financial planning and advice at Principal in Des Moines, Iowa, said:
“First and foremost, there are always going to be implications if you take from savings. The key is to make the most objective and pragmatic decision you can.”
401(k) Withdrawals: Who and When Can Tap Retirement Accounts
The CARES Act signed by U.S. President Donald Trump in late March allows withdrawals up to $100,000 (or the account balance, if lesser), without penalty. Paying the funds optional. For struggling business owners and workers, tapping retirement accounts seems like a good option. However, the terms are available not for everyone.
Firstly, the account owner, their spouse or dependent must have been diagnosed with COVID-19 or impacted financially because of the pandemic. Secondly, the coronavirus related distribution (CRD) is taxable as ordinary income, with the tax eligible to be paid over three years. You can pay the money back within three years and file amended tax returns to recoup the tax you have already paid. Exempt from the 10% penalty, you can spend CRD money for any purpose.
In an ideal situation, you wouldn’t withdraw funds from your 401(k) account until after you retire. You would still pay income tax on those withdrawals just as you did with each paycheck you earned being employed. But because of the pandemic, rules are now different. A hardship COVID-19 withdrawal allows you to get funds from your account to meet an “immediate and heavy financial need.”
As Fidelity Investments has estimated, the average amount withdrawn was about $13,000. More than 8,500 people took $100,000.
401(k) Loans amid COVID-19 Crisis
Another option amid the COVID-19 crisis is taking a loan from your 401(k) account of up to $100,000 (as a rule, the limit is $50,000) and defer payments until next year. Its advantages include speed and convenience, repayment flexibility, cost advantage, and potential benefits to your retirement savings in a down market.
The loan interest is typically for five years and represents a formula “Prime + 1%.” Additionally, it uses a contribution rate of 6% of salary plus a 50% match from the employer. But the balance becomes due if you leave your job earlier and may end up counting as a distribution with taxes due.
As the research on 401(k) loans and defaults has shown, 39% of loans go to repay debts and 32% – for home repairs or improvements. Other major uses included automobiles, college tuition, medical costs, and vacation or wedding expenses.
According to Heather Winston, you should weigh up all the pros and cons considering withdrawal or loan. Besides, it is best to first look into other options that wouldn’t reduce your retirement savings. If there are no, then think carefully about the amount you will need.
“Think through how much you might really need, not just what’s available to you. You could take up to $100,000, but do you really need that?”
And if you can continue making contributions, it’s better to do so.