Considering Taking a Hardship Distribution from Your Retirement Plan?
The coronavirus pandemic is leaving millions of Americans on furlough or out of a job, dealing with reduced hours or workload… but NOT with reduced monthly bills to pay. For many, this is a time of financial hardship. Sadly, according to a 2018 Federal Reserve report, 40 percent of adults cannot cover a $400 emergency expense and the current situation goes far beyond that.
Sometimes, individuals consider dipping into one’s retirement plan to cover short-term expenses. Among the emergency expenses that may qualify for such a withdrawal are tuition/education expenses; down payment or repairs on a primary residence, rent or mortgage payments (to thwart possible eviction or foreclosure); out-of-pocket medical expenses; and funeral costs.
- The withdrawal amount has been limited to the amount of the emergency expense
- The plan participant pays income tax on the withdrawal plus a 10 percent penalty if under 59½ years old
- If a 401(k) design allows for loans (not all do), people taking loans against their 401(k) plans must repay the full loan amount with interest; lack of repayment can trigger additional penalties
- In addition, participants’ contributions from their paychecks into their 401(k) plans are suspended for at least six months after taking the hardship distribution
Changes with the CARES Act
This stimulus package has loosened the rules around taking hardship withdrawals from retirement plans, and loans from 401(k) plans. A CARES Act provision allows individuals who are facing adverse financial consequences due to COVID-19 to withdraw funds from their retirement accounts without penalty (regardless of age). This applies to IRAs and 401(k) plans.
The withdrawal must be made before December 31, 2020 and can be up to $100,000. Tax payments on this income are extended out three years. For those taking loans against their 401(k)s, that amount is also raised to $100,000. Note that there are no loans from IRAs.
Why gamble with your retirement savings?
Many financial experts argue against taking out a hardship loan from one’s 401(k) plan to avoid reducing any retirement savings, when there are other loan options available (such as a home equity loan, SBA loan, or other lines of credit). And, all good intentions aside, it may be difficult to replace the funds from a hardship distribution from an IRA or other retirement plan—and then rebuild on that money for retirement.On top of that, the stock market has suffered a tremendous downturn, with subsequent volatility almost daily, as a result of COVID-19 and the economic stressors stemming from lockdowns.
Weathering market volatility through self-direction
Self-directed investors have greater leeway when it comes to hedging against that stock market volatility. That’s because of the many alternative assets that can be held in a self-directed retirement plan. Investing in real estate, precious metals, private equity, or other non-publicly traded assets give savvy investors many more ways to build a more diverse retirement portfolio that have stronger potential to weather the COVID-19 storm (and other times of economic uncertainty). One reason is because the returns on nontraditional investments in a self-directed IRA do NOT directly correlate with stock market returns.
You can even loan funds from your self-directed IRA to someone who is dealing with a cash flow shortage, with the terms worked out between both parties, and receive interest and principal paid back to your IRA.
As always, it is best to consult your trusted financial adviser about how to navigate financial hardship as it relates to your retirement plan. At Next Generation, we’re here to answer any questions you have about self-direction as a retirement strategy, or about the many alternative assets allowed in these plans. You can schedule a complimentary educational session to learn more or contact us directly via phone at 888.857.8058 or email NewAccounts@NextGenerationTrust.com.