Susan Tompor: How to break into your retirement piggy bank in the crisis

Apr. 24--The piggy bank of last resort, known as your 401(k), is far easier to crack now for those enduring financial trauma in the fight against the coronavirus pandemic.

No one likes the thought of dipping into long term savings, but the financial picture for many families is becoming increasingly bleak. On Thursday, the U.S. Labor Department reported that more than 26 million people filed unemployment claims in the five weeks through last April 18.

In Michigan, about 134,000 workers filed claims a week ago -- bringing the total number to nearly 1.8 million since March 15.

Stimulus checks, enhanced jobless benefits and short-term options to postpone paying the mortgage will help fill the gap for many.

Some people may have an emergency savings account that can cover three months or more of expenses. And they should definitely tap into that savings first.

Plenty of people, though, don't have much readily available savings. Many faced financial challenges long before heading into the COVID-19-induced recession. And then they lost a paycheck.

But they often do have a 401(k), as many companies currently have automatic enrollment where they withhold a certain percentage of an employee's pay to put into the plan.

"Many people found themselves in this current crisis having no job but some assets locked into a long-term retirement plan," said Dave Stinnett, principal, head of the strategic retirement consulting group for Vanguard.

Congress recognized that the financial crisis is serious and put emergency-like measures in place in the CARES Act, or the Coronavirus Aid, Relief, and Economic Security Act. Some of these measures are similar to relief offered to a community that was just hit by a hurricane or tornado.

The coronavirus relief package, for example, could make it easier to avoid penalties when tapping into retirement savings. Special breaks may be allowed only if your employer has agreed to offer them, but they're clearly worth researching if you're risking foreclosure on your home or facing other serious financial challenges.

Some workers were able take advantage of COVID-19 related withdrawals as early as April 8 in some Fidelity-managed plans, according to Meghan Murphy, a vice president at Fidelity.

The average amount of the withdrawals from Fidelity-run plans is $13,000 -- well below a $100,000 maximum allowed under the coronavirus relief act, she said. The average is influenced by a small group of more sizable withdrawals. The median is $5,500 -- with half of the withdrawals being more than that amount and half less.

Employers, she said, keep reviewing the new coronavirus relief options and many will likely offer them to their workers in the weeks ahead. Some employers might notify you directly; others are making COVID-19 options available when workers ask about it.

Here's a look at what you can do under three significant retirement-related changes:

Withdraw big money without penalties

Need to get more cash due to COVID-19? The 401(k) may be an option, no matter what your age.

People affected by COVID-19 -- through a health issue, job loss or cut in wages -- are now able to withdraw as much as $100,000 in 2020 from 401(k)s and 403(b)s, as well as traditional individual retirement accounts.

The maximum $100,000 withdrawal is the most you can withdraw in total from all retirement accounts. So if you're fortunate enough to have two or three accounts, you can't withdraw $200,000 or $300,000 and see the same favorable tax treatment.

The relaxed rules can help you avoid penalties and taxes associated with regular withdrawals.

For example, you'd avoid the 10% early withdrawal penalty if you're younger than age 59 and a half. But remember, you must have been affected by the coronavirus -- such as being diagnosed with the virus, having a spouse or dependent who is diagnosed with the virus, or facing adverse financial conditions, such as being laid off, said Vanguard's Stinnett.

Such penalty-free withdrawals are allowed only in 2020.

In addition, you wouldn't be subject to a mandatory 20% withholding for federal taxes. You'd still owe taxes but the tax bill could be spread over tax returns for 2020, 2021 and 2022.

And if you put the money back into the retirement account within three years, you could amend your earlier tax returns and ultimately avoid paying taxes on the COVID-19 withdrawals.

"Using a 401(k) is not a bad idea, if you're taking a loan against it and you're essentially paying yourself back," said Dave Desmarais, a certified public accountant and member of the American Institute of CPAs personal financial planning executive committee.

Desmarais, a Boston-based certified public accountant in the private client services group for KLR, said people could aim to pay back that withdrawal as their situation improved in the next few months or years.

No one should make this move casually. You are likely withdrawing money from a 401(k) at a time when the stock market is extremely volatile and you could be locking in huge losses here.

And you're also possibly setting yourself up for more scrimping in retirement, too.

"People need to understand that this is not free money without long-term consequences," Stinnett said.

Take out a big loan

Some employers won't allow this coronavirus-related loan option yet but others are adding it. So you must check with the rules associated with your own 401(k) plan.

If you're still employed, the COVID-19 relief act would allow a limited window for you to take out a loan from your 401(k) of up to 100% of your vested balance or a maximum of $100,000 -- whichever is less. It only applies to plans that allow this type of a loan, though.

So if you had $30,000 sitting in the account, you could borrow all of it from the plan. The regular rules would have required that the loan limit would be 50% of your balance -- or $15,000 in this example.

You can defer payments for one year but you will need to pay it back.

Based on the tax rules, Desmarais notes that you'd effectively get up to six years to repay such a loan taken out in 2020. In addition, he said, those with existing 401(k) loans also may delay repayments that otherwise would have been due between March 27 and Dec. 31 for one year.

Still, take time to review the loan option versus a withdrawal with a tax professional and other advisors. Be especially careful with any loans if you expect that you might lose your job or change jobs in the future.

If you take the loan, you're committing to repaying a set amount of money per paycheck, according to Fidelity's Murphy. And that's money you won't be able to pay toward other bills in the future.

If you leave the company or lose your job, you're going to need to pay the balance owed on the loan back in full, possibly within 90 days, depending on your employer plan, Murphy said. If you don't come up with the money to repay the loan, the remaining amount outstanding would be taxable.

Under the Tax Cuts and Jobs Act of 2017, Desmarais said, you don't have to pay taxes or the 10% penalty, if that applies, if you repay the loan by the due date of your tax return for the year when you leave your job, including any tax extensions. For example, if you leave your job in 2020, you'd have until April 15, 2021, to repay the loan (or October 15, 2021, if you file an extension).

Delay required withdrawals from retirement accounts

Some retirees who have access to other cash may not want to lock in some losses after the dramatic fall in stock prices during the pandemic. So they may want to avoid taking required minimum distributions in 2020.

If you turned 70 and a half in 2019 or earlier, you typically must take the required minimum distribution from your retirement savings each year. Thanks to the SECURE Act, some retirees will start dealing with RMDs when they turn 72.

Such distributions are taxable and they are based on the balance in your retirement accounts, as well as your age.

You're not required to double up on distributions in 2021 if you decide to skip taking a required minimum distribution in 2020. You don't need to keep any additional tax records if you skip taking a distribution.

Many people, of course, need their retirement money in retirement so they're still going to take distributions. But some may want to take out less money than required if they're aiming to wait out the storm on Wall Street.

Contact Susan Tompor at stompor@freepress.com. Follow her on Twitter @tompor. Read more on business and sign up for our business newsletter.

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