The Coronavirus Aid, Relief, and Economic Security (CARES) Act provides financial relief for those who have been negatively affected by the COVID-19 pandemic. One of its provisions allows eligible individuals to withdraw up to $100,000 this year from IRAs, 401(k) plans and certain other retirement accounts without triggering the 10% early withdrawal penalty. Account owners can avoid taxes altogether by redepositing the withdrawn amounts to their accounts within three years.
This provision extends a welcome lifeline in challenging economic times. However, withdrawing retirement funds, even penalty-free, comes at a steep price and may be viewed as a last resort.
CASE IN POINT
Let's look at an example of how withdrawing funds from an IRA account can take a big bite out of retirement savings.
Ethan, age 55, has $500,000 in his IRA and plans to retire in 2030. If he leaves the funds in the account and contributes an additional $7,000 per year, the account will grow to $1,180,868 at retirement (assuming an eight percent rate of return).
Suppose, instead, that Ethan withdraws $100,000 in 2020. Under this scenario, the IRA will be worth $964,976 at retirement, reducing Ethan's savings by $215,892, not to mention taxes on the $100,000 withdrawal. Even if he is able to redeposit the $100,000 into his IRA in three years, the lost earnings on those funds will cost him nearly $45,000.
PLAN LOANS
As an alternative to withdrawing retirement funds, you might borrow from a qualified retirement plan, which is permitted by some plans. Many people mistakenly view these loans as “free,” because there are no taxes or penalties and you generally pay interest on the loan to yourself. But just like the withdrawal that is redeposited in the previous example, plan loans come at a steep cost in the form of lost tax-deferred earnings. And if your plan prohibits participants with outstanding loans from making contributions and receiving matching contributions, the cost is even greater.
Retirement plan loans also come with a significant risk: If you lose your job and cannot repay the loan, you may owe taxes and penalties on the outstanding loan balance.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.