COVID-19 has brought chaos to the financial world, shattering the US economy, and driving millions into unemployment. Many are uncertain of what life would become even if the virus is finally defeated.
Thankfully, the CARES Act, which was signed into law in March, has a key provision designed to bail Americans out of financial difficulty when exercised. It’s the option that allows you to take penalty-free withdrawals from your retirement accounts.
Typically, making withdrawals from your IRA or 410(k) before you reach the age of 59 ½ attracts a 10% early withdrawal penalty. Why? Since owners of retirement accounts enjoy tax breaks on their contribution and investment gains, they are asked to leave the money in the account until they retire. The penalties are put in place to dissuade people from withdrawing.
With the financial crisis that accompanied the pandemic and the CARES Act passing, individuals affected negatively by the COVID-19 can now withdraw from their accounts without being subject to the penalty. The option allows withdrawals of up to $100,000 from retirement savings.
Surprisingly, many people have not exercised this option, and the majority didn’t even take any COVID-19 related distributions.
Most Retirement Savings Accounts Are Still Intact
Despite the good intentions behind creating the CARES Act, most employees fear that taking withdrawals from their IRA and 401(k) accounts may deplete their retirement savings accounts prematurely, leaving them with insufficient funds later on. So it’s no surprise that there have been fewer coronavirus-related withdrawals across the country.
According to a Vanguard report, only 1.9% of retirement savers made withdrawals from their retirement accounts through the CARES Act since May 31. The report places the median distribution amount for those who did at $10,413. It also showed that about 30% of the withdrawals made because of the coronavirus were under $5,000, while only 4% took the maximum withdrawal amount of $100,000.
All of this is good news, as it shows a high level of financial awareness amongst Americans. The more people withdraw from their retirement savings, the less they stand to retire. And more withdrawals equate to missed investment opportunities.
Let’s say a 35-year-old retirement saver makes withdrawals of $5,000 from their IRA account to cover household bills. The retirement account generates an average of 7% annually to his or her retirement account. If that person retires at the age of 65, they will have $38,000 less in savings because of that withdrawal. While these simple retirement savings and withdrawals may look small, it will be a huge sum when coupled with the force of compound interest in the long run.
There’s a need to reduce withdrawals from your retirement savings for coronavirus-related expenses to the barest minimum, despite the $100,000 cap. Doing so will minimize the damages to your retirement savings in the long run.
Another reason to minimize withdrawals is the tax components of a traditional IRA or 401(k) account. Traditional retirement plans are subject to taxes, even with the CARES Act. Note that these are not penalties, as they still apply even if you withdraw in retirement.
Though the CARES Act allows for taxes on retirement withdrawals to be paid within three years, it’s still a major turnoff, and it’s one more reason to minimize withdrawals.