Financial risks remain as more Americans dip into 401(k)s due to COVID-19
Nearly 30% of Americans report that they've dipped into their retirement funds, but will that add even more to their burden?
While divorce has often been a major historic factor in whether people decide to make an early withdrawal from their retirement plan, there’s a new factor in the mix now: COVID-19.
Nearly 30% of Americans reported that they have dipped into their retirement funds because of COVID-19, according to a MagnifyMoney survey of 1,239 people. In addition to raiding their retirement accounts early, 21% said they lowered the amount they’re contributing, and 26% have stopped making payments.
Of those withdrawing funds, 52% said it’s to cover basic expenses.
“The fact that the majority of respondents were withdrawing funds to cover essential expenses highlights a disheartening reality,” according to the report. “Our survey revealed that 60% of respondents used their golden-year funds to pay for groceries, 42% spent it on household bills, 31% used it for rent or mortgage payments and 27% used it for debt payments. Another 20% haven’t spent the funds yet.”
Divorce and job loss have historically been key factors in whether people dipped into their nest eggs, according to a study by economists Frank Stafford of the University of Michigan and Thomas Bridges of the University of Delaware.
Their study, though, did find a silver lining: “The researchers did not find that homeowners were cashing in their retirements or reducing their contributions in order to remodel their homes or make other large purchases. This suggests that families are less willing to use their pensions savings as a ‘convenient ATM’ for discretionary durable purchases,” according to their report.
With COVID-19 sacking the economy, though, Congress passed the $2 trillion CARES Act in March that includes provisions allowing employers to let people tap their 401(k) or IRA plans and avoid certain tax penalties.
For those affected by COVID-19, the main changes allow for withdrawals of up to $100,000 total between all retirement accounts without paying a mandatory 20% withholding tax and 10% penalty for those younger than 59.5 years old. The changes also double the amount that can be borrowed. That limit is now $100,000 or 100% of the vested account balance, whichever is less. If people already have a loan from their retirement account, they can also suspend those payments for a year.
Those changes came as unemployment skyrocketed. Nearly 40 million people have filed for unemployment benefits since mid-March, according to the U.S. Department of Labor.
While the financial needs that warrant dipping into funds is real, the risks are still there, especially for people who are heavily invested in stocks.
“If you’re predominantly a stock investor, the market value of your retirement fund has probably fallen starting with the swift market decline of March,” according to a Vanguard report. “So if you withdraw your money now, you may be selling funds and locking in those losses at a low point. History tells us that when markets rebound after a downturn, it typically happens fast. Withdrawing your retirement funds now may prevent you from benefiting from any rebound.”
Dipping in early also means people may have to contribute more later in their career to catch up, or work longer than they planned.
Loans could be a better option for people in a financial pinch, but that still carries risks under the CARES Act.
“The biggest risk of any retirement plan loan is that you won’t be able to pay the money back,” according to Vanguard. “If that happens, the unpaid balance is considered taxable income. You would owe ordinary income taxes and, if you are under age 59½, there is a potential 10% early withdrawal penalty tax as well. The tax burden could be significant, and that could take a serious toll on your savings.”
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