Early Withdrawals: impact of covid-19 on retirement savings

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By Disha Gupta

In the United States of America, a lot of states are gradually reopening local economies after the first wave of COVID-19 halted most business operations due to rapid spread through contact. Most states were completely closed for two or three months; the country lost over 20 million jobs. The unemployment rate reached approximately 15%, a level last seen during the Great Depression of the 1930s - almost double the rate during the 2007-2008 financial crisis. Some companies and families have suffered grave financial damage to their income due to these economically silent months. In some cases, alleviating this damage requires more than dipping into their savings accounts to make the business bloom again. In these difficult times, families are turning to their future retirement funds to survive their harrowing present. 

When talking about retirement, two terms come to mind: 401-k and Roth IRA. They both are retirement investment accounts; if magnified, however, they have several disparities. A 401-k is an employer-given retirement plan: a percentage of the pretax pay given is invested in this account. On the other hand, Roth IRA (Individual Retirement Arrangement) is, as the name suggests, created individually. A person can start a Roth IRA account by themself regardless of their employment status. The main differentiating factor of Roth IRA is that one can contribute to it with after-tax money and therefore allowing their savings to expand without further taxing burdens. Besides these aspects, Roth IRA and 401-k differentiate on the contribution limits and Required Minimum Distributions, or RMDs. The 401-k has its advantages with the Employer Contributions, where many employers offer a match based on the percentage of gross income going into one’s account even though it's not required by the government. On the other hand, The Roth IRA has its advantages with the investment menu, where one has an extensive variety of investment options and more power over how one invests. On a more similar note, both options come with the same penalties for withdrawing before the age of 59½. Currently, this is the concern of many who want to withdraw from their accounts due to the great pandemic but have yet to celebrate their 59th birthday. 

Under normal circumstances, the penalty for withdrawing from 401ks and IRAs before the age of 59½ can be charged as 10% of the distribution. But circumstances are anything but normal right now with the virus over our heads; henceforth, the CARES Act has been put in place to ease some of the burdens off these families suffering from the virus. The Coronavirus Aid, Relief and Economic Security Act, or the CARES Act for short, has put aside 2 trillion dollars to economically protect and provide relief in the throes of the pandemic. As listed under this act, individuals affected severely by the coronavirus can make emergency withdrawals of up to $100,000 from both employed-provided retirement accounts like 401k as well as personal accounts like Roth IRAs. And those underage can also avail this offer without the usual 10% penalty for the distributions made in the year 2020. At first, the offer extended only to people who tested positive for the virus - or had a spouse who tested positive - and those laid-off or furloughed, but now the policy has been revised to include individuals whose jobs’ start dates were delayed. That being said, the money withdrawn early are still taxed as income spread evenly over these three years (2020, 2021, 2022). For example, if one receives a $12,000 distribution, you could report $4,000 in income on your income tax return for each year from 2020 to 2022. But the silver lining is that one can claim a refund on those taxes should they pay back the amount they took out within three years. One critical thing to keep in mind, however, is that this money is withdrawn during a relatively stagnant market, thus restraining its potential to grow and increase again when the market bounces back up. 

Overall, the bottom line is that using cash from retirement accounts should always be one’s absolute last resort. The key to withdrawing early in these difficult times is to be maximally conservative: only take out what is irrevocably necessary and try to pay it back as soon as possible.