Pulling money early from your retirement funds always carried the stigma and pain of a 10% financial penalty. Besides, everyone will tell you that you are always better off leaving retirement money to grow tax free in the market while you are young. I believe this is good advice to live by, as the more you remove from your retirement the less you have will have in your later years when you are not working.
Also, the power of compounding interest is best achieved when you load up investment every month, during both good times and bad. Well, the presence of COVID-19 can certainly be classified as a very "bad time" for many reasons.
Conventional financial wisdom tells you to keep adding to your retirement savings- don't kill golden goose! There is however a new scenario to consider- Does the CARES act offer an early Retirement Pull Opportunity for you?
Reason for pulling money from retirement:
As written in this really interesting magnify money article, https://www.magnifymoney.com/blog/news/early-withdrawal-coronavirus/ , there are plenty of reason to withdraw money from retirement funds during a crisis if you lose your job, need to care for older family members and other expenses.
Are you still contributing to your retirement?:
This breakdown from the same magnify money article linked above shows who is still adding to their retirement accounts. It looks as though baby boomers have the highest percentage of paused retirement contributions. I am glad to see that 64% of Gen-X'rs are leaving their retirement contributions in place, which is higher than the overall 53% average.
The Over Saver:
What if you have Over Saved for your retirement, and you are under the age of fifty-nine? That's right, what if you have too much money put away in 401k's, IRA and SEP's. Based on your age, life expectancy and retirement balances, what if your retirement money will considerably outlive you? I expect that there are some people ready for retirement in terms of funds, but they aren't willing to withdraw money because of the tax implications.
For some people in this situation, setting up a 501(c)(3) foundation is a potential option that will allow your money to go to good use beyond your time. You can setup a foundation to focus on a particular type of giving, or even a segment of society that you would like to help. Furthermore, your kids can help run the foundation when you are gone. I've read that charitable foundations can pull 10% of the assets in order to pay for foundation salaries and costs. Consulting a legal and financial professional team would be the right way to figure this out.
Care's Act:
The recent addition of the CARE's act does allow everyone to execute an early withdrawal up to $100,000 dollars from their retirement accounts without any tax penalty. Consider a married super saver couple with no assets in cash or post tax brokerage accounts, and too many assets in their retirement accounts. In theory, this couple could withdraw a total of $200,000 dollars without the tax penalty, thereby immediately creating a more balanced cash to retirement accounts ratio.
You will need to identify that you are impacted by COVID-19. There are four types of circumstances centering in the impact, such as job loss, impact of quarantine, etc. Make sure to read through the entire legislation to understand if you qualify. Although you will be shielded from the 10% early withdrawal penalty, there is still a tax hit you will incur, however that hit can be spread out over multiple years.
Much of what I read about in the financial retirement world focuses on tax avoidance strategies and opportunities. The CARE's act appears to be one of those tax saving's opportunities if you are in need of a greater cash position, and you have only saved money into retirement accounts. Although, before exercising this new CARE's act 10% penalty exemption, I would consider a few key factors:
-Do you really need the money from your retirement funds now?
-Are there other options that would allow you to leave the retirement fund balances in place and pull from other assets?
-Are you going to negatively impact your future retirement picture?
-Most importantly, what is the opportunity cost for this money?
What to do with $200,000 dollars:
Let's return to the super saver couple who decides that they can now safely pull $200,000 dollars from their retirement savings and avoid any early penalties. Off the top of my head, here are several ways to spend those funds:
(i) Move $12,000 into two Roth IRA's. By doing this you could create a Roth using pre-tax retirement dollars, this Roth will remain tax free in terms of future withdrawals, for ever.
Yes, it sounds counter intuitive to move retirement money from one account to another retirement account, but consider the alternative. If you were to execute a Roth conversion strategy, you would be required to pay taxes on the money you move over into a Roth. Using the penalty free retirement money to move into another tax free retirement vehicle could be a good option. There are some income limits tied to Roth contributions, so you would need to do some work before exercising this option.
(ii) Purchase rental properties, or payoff existing rental properties. There is a divisive discussion whenever one raises the idea of paying off properties versus maintaining a loan balance on them, effectively allowing your tenants to pay down your mortgage for you slowly overtime. This discussion has more to do with your personal approach to borrowing money in order to make money. Your age and overall financial plan will also factor into this decision. If you are in the position to pay off your rental using money that has grown tax-free, this options could be a good one.
(iii) Fund a new business venture. If you can create a successful business, just think how smart you will feel when you realize that you funded this venture with tax free dollars that would under normal circumstances would cost you a 10% tax off the entire withdrawal.
(iv) Move the $200k into a online saving's account. You will certainly rest better knowing that you have available liquidity not tied into a required minimum distributions. Nothing wrong with having extra cash on hand. You will however need to be comfortable with a small 1.5% interest for these extra funds.
Now for the important disclaimer:
Note that I am not a financial or legal professional, nor am I licensed to sell securities, or offer any financial advice. I am only an expert of my own finances. Given this statement, consider this blog as entertainment value only. Although, I sincerely hope that I can motivate you to learn to build your own financial knowledge and wealth.