Coronavirus-based layoffs are tempting workers to cash in 401(k)s early, CNN reported. As people need to find options for paying their bills during stay-at-home measures, restrictions have been eased for early 401(k) withdrawal. However, there’s plenty to consider before doing so.
According to CNN, the stimulus package passed by Congress and signed by President Trump included alterations to the way 401(k) accounts are handled. “As part of the massive stimulus bill, those affected by coronavirus (either by a diagnosis within their family or financial hardship due to the outbreak, according to the new rule) can now pull up to $100,000 out of a retirement account, including a 401(k) or IRA, without the 10% early-withdrawal penalty,” the article said.
“The money you can take from your 401(k) can be re-contributed within three years, even if it exceeds the maximum contribution limits for that year. While the distribution is taxable, that tax liability can be spread out over the next three years.”
There are a lot of ins and outs to a retirement account like a 401(k), some of which you should consider before cashing it.
Understanding 401(k) Accounts
“Many employers offer 401(k) retirement plans that put off the need to pay taxes on both the contributions you and hopefully your employer make plus the plan’s earnings until you withdraw funds from the plan, hopefully after retirement,” said Sally Hurme, J.D., law expert and author. “These 401(k) plans are called defined-contribution plans—you have made a specific dollar contribution with each paycheck to a personal plan account.”
According to Hurme, the plan places your contributions into various investments, like mutual funds or other investments that you selected from its “menu” when you first opened your 401(k). Many employers will also contribute to their employees’ 401(k) accounts over the years, although there’s a catch with the payout.
“Unlike fixed pension payments, the amount you are going to receive depends on the performance of the investments, which may be positive or negative,” Hurme said. “You, instead of your employer, bear the investment risk.”
Withdrawal Options for Your 401(k)
Hurme said that once you withdraw from your 401(k) account, the amount you withdraw becomes taxable as regular income unless you roll that money over into an individual retirement account (IRA). Due to this, she urged speaking with a financial expert or the employer’s human relations department before selecting an option for withdrawing any 401(k) money. There are several options available to withdraw from your 401(k) that vary by employer, but she listed several of the typical ones the employee might see.
“You can take a total distribution in which you get a single payment of all funds, which can be paid directly to you or rolled over into an IRA,” Hurme said. “If you don’t reinvest in an IRA or other qualified plan, you’ll pay taxes on the full amount, which could be a big bite out of your nest egg.”
Installment distribution, also called periodic distribution, is another option. With this option, you receive a specific amount monthly for a set time period, both of which you choose. It also comes with the added option to name a beneficiary who will receive the remainder of the payment in the event that you pass away during the period of distribution.
“With a life annuity you will receive guaranteed monthly payments as long as you live,” Hurme said. “If you are married or have a domestic partner, you’ll need his or her written consent to select this option. When you die, the insurance company keeps any remaining funds.”
Finally, a joint surviving spouse annuity is similar to a life annuity. You take a reduced amount during your lifetime, but in exchange for that, if your spouse or domestic partner outlives you, they receive 50 percent of the amount you received for the rest of their life.
With so many 401(k) options available, Hurme strongly suggested hiring a financial planner to help you make sense of your retirement savings, and to help you choose a withdrawal option and how to decide what to do with the money you receive.
Sally Balch Hurme, J.D., contributed to this article. Hurme is an elder law expert and author who has led the national conversation on many of the legal issues of concern to older persons and their families. She received her B.A. in Political Science from Newcomb College of Tulane University and her J.D. from the American University Washington College of Law.