Before You Take an Early Retirement Plan Withdrawal Because of COVID-19, Do This

The CARES Act allows for penalty-free retirement plan withdrawals. But it pays to explore other options before raiding your IRA or 401(k).

by

The COVID-19 crisis is hitting Americans hard. Whether you've lost your job, your income has decreased, or you're grappling with higher expenses, you may be desperate to increase your personal cash flow right about now. And that could mean raiding your retirement plan early.

Thanks to the CARES Act, which was passed in March to provide relief during the pandemic, it's now possible to withdraw up to $100,000 penalty-free from an IRA or 401(k) if you've been affected by the crisis. Normally, taking a withdrawal before age 59 1/2 results in a 10% penalty on the sum you remove, and that's money you can't get back. But right now, that penalty is waived if your need for cash stems from COVID-19's impact.

https://g.foolcdn.com/image/?url=https%3A%2F%2Fg.foolcdn.com%2Feditorial%2Fimages%2F575659%2Fman-holding-document-and-envelope_gettyimages-1163762156.jpg&w=700&op=resize
IMAGE SOURCE: GETTY IMAGES.

Still, taking an early retirement plan withdrawal should really be a last resort. The reason? Any money you remove now is money that won't be available to you when you're older, and though you may be struggling now, your future self might struggle even more in the absence of adequate retirement savings.

Furthermore, when you take an early retirement plan withdrawal, you don't just lose out on the sum you remove; you lose out on the amount that sum could've grown into. Imagine you have your retirement plan invested so that it generates an average yearly 7% return (that's a bit below the stock market's average). If you withdraw $10,000 today to cover expenses but don't retire for 20 more years, you'll actually wind up almost $39,000 short when you factor in missed investment growth on that $10,000.

If you're in a tough spot right now and need money, you may have no choice but to turn to your retirement savings. But before you do, you can try these things first.

1. Withdraw from your emergency fund

You may be hesitant to use your emergency fund now, because any money you remove from it is money you won't have for a different crisis. But remember, the purpose of that account is to provide you with income for situations you couldn't have predicted, so rather than feel guilty about raiding your emergency savings, or be scared to do so, go ahead and dip in. Times like these are what your emergency fund is made for.

2. See if you qualify for a low-interest loan

Racking up charges on a high-interest credit card is a bad idea during any crisis, including this one. But if you manage to secure an affordable loan, borrowing could be a better bet than taking money out of your retirement plan. If you own a home, you may qualify for a home equity loan or line of credit with a reasonable interest rate attached to it. And if your credit is strong, you may qualify for a relatively low-interest personal loan.

3. Look into a cash-out refinance

With a cash-out refinance, you swap your existing mortgage for a new one, only you borrow more than your remaining loan balance so you're able to use that excess cash as you please. For example, if you have $120,000 remaining on your mortgage, you can do a cash-out refinance that gives you $140,000. The first $120,000 will be needed to pay off your home, while that extra $20,000 is yours to use. Of course, as is the case with a home equity or personal loan, you're still borrowing money here, but you may be able to do so affordably given today's relatively low mortgage rates.

When money is tight and you have long-term savings that belong to you, it can be tempting to tap an IRA or 401(k). And now that the penalty for doing so early is off the table (assuming you can prove a COVID-19-related hardship), a retirement plan withdrawal can be even more enticing. But remember, if you don't leave yourself enough money for your senior years, you'll risk struggling financially later in life. As such, it pays to do whatever you can to leave your retirement savings alone, and only consider a withdrawal once all other options have been exhausted.