Should I Borrow Against A Retirement Account?
As part of the CARES Act, a coronavirus stimulus package that was passed in March, people with 401(k) accounts became eligible to take out CARES distribution and tap into their retirement accounts early. Forbes reported that as of mid-April, 164,950 individuals covered under 401(k) and 403(b) workplace retirement plans that it administers already had taken out large sums of money.
So, if you can borrow against your 401(k) during a financial crisis, then how do you borrow against a retirement account safely without affecting your finances in the future? The IRS has created an FAQ page for coronavirus-related questions regarding retirement accounts and IRAs. But, we’re here to help you make sense of the complexities and answer the question: is it even a good idea to borrow against a retirement account?
When is the Best Time to Take Out a 401(k) Loan?
Kathryn B. Hauer, the author of Financial Advice for Blue Collar America, spoke with Investopedia about the best time to take out a loan against your 401(k) account. "Let’s face it,” she said, “in the real world, sometimes people need money. Borrowing from your 401(k) can be financially smarter than taking out a cripplingly high-interest title loan, pawn, or payday loan, or even a more reasonable personal loan. It will cost you less in the long run."
Usually, the rules of borrowing against your 401(k) are pretty standard in that receiving a loan is not a taxable event unless the loan limits and repayment rules are violated. It also doesn’t impact your credit score. So, the best time to take out a 401(k) loan is usually whenever it makes sense according to your personal finances. However, with the introduction of the CARES Act, there’s a new caveat.
Can I Borrow More Against My Retirement Account Due to the CARES Act?
Yes, actually, you can! So, if you need emergency money fast, it might be one of the best options. Usually, you’re only able to tap into $50,000 or 50% of your vested account, whichever is higher. Under section 2202 of the CARES Act, you can now request up to an aggregate limit of $100,000 from all plans and IRAs.
However, the requirements for who is eligible continue to change. You are eligible to borrow against your 401(k) or another retirement account if:
- You, a spouse or dependent tested positive for COVID-19.
- You experience adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced.
- You experience adverse financial consequences as a result of being unable to work due to a lack of child care due to COVID-19.
- You experience adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to COVID-19.
Is There An Additional Tax on Coronavirus-Related Retirement Loans?
Some financial experts might tout the idea that 401(k) loans aren’t tax-efficient simply due to the fact that you have to repay them with post-tax dollars. This usually means that you’re essentially paying double the tax. Sometimes, you might also face a 10% tax penalty if you’re under 59.5 years old.
However, with the new rules under the CARES Act, the 10% additional tax on early distributions does not apply to any coronavirus-related distribution. As well, the IRS has noted that Section 2202 of the CARES Act allows for an additional year for repayment of loans from eligible retirement plans (not including IRAs). So, you have more time to pay off the loans which means you can distribute them out over the few following tax years if it works out better for you in that way.
Should You Borrow Against Your Retirement Account?
The answer to this question is truly dependent on your individual financial situation. If you’re experiencing financial hardships due to the coronavirus crisis then it might make sense, as financial experts argue that the negative myths surrounding the idea of borrowing against your retirement account simply aren’t true. It’s relatively easy and financially safe, offering you cost advantages, repayment flexibility, and, now, the chance to borrow without many of the usual penalties.
However, you’ll definitely want to take a look at a retirement calculator to figure out how much you’ll owe in the long run depending on your specific employer’s adopted COVID-19-related retirement provisions. If you don’t need that much money, it might not make sense to even think about touching your 401(k). Instead, think about other ways in which you can earn extra money for emergency spending.
Other Options for Accessing Extra Cash
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