Early 401(k) withdrawal penalties have been lifted by the CARES Act, but there are other options to consider.

Usually, taking money out of your 401(k) early means paying a penalty plus income taxes. However, these are not usual times. The CARES Act that became law at the end of March lifts penalties for coronavirus-related early distributions. Tapping into retirement accounts might make sense but there are pros and cons of taking money out of your 401(k) early that you should consider. Plus, there are other options that could help you get through financial hardship.

Pros of taking money from your 401(k) now

If you have no other funds and no income, an early distribution could help keep a roof over your head and your bills paid. The CARES Act is designed to assist people in hardship by lifting the 401(k) withdrawal rules that impose a 10% penalty for taking out funds before age 59-and-a-half. So, you get a break on that.

Taking a coronavirus-related distribution is not considered a loan; you could pay the amount back, but you’re not required to.

Cons of early withdrawal

While the 10% penalty is waived you’ll still owe income taxes on the withdrawal, which will have to be paid over the next three years. If you repay the distribution within three years, you’ll get back income taxes you paid on the funds.

Perhaps a bigger consideration is what early withdrawal means to your future. Using funds now could affect your retirement planning strategy and could potentially mean less money when you retire.

Alternatives to tapping your retirement money

Before taking a distribution from your retirement account, you should consider these alternatives:

• Talk to your mortgage company and lenders to see what kind of assistance they can provide. A forbearance agreement with your mortgage lender could allow you to reduce or pause your monthly payments. Credit card companies will often work out a payment plan with you.
• If you have assets like a mutual fund or stocks, you could consider selling these for cash. If you have to sell at a loss, you might be able to take a tax write off.
• If you qualify, a home equity loan or home equity line of credit (HELOC) or a personal loan could give you access to cash.
• Take a loan from your retirement plan. The CARES Act doubled the maximum loan amount from $50,000 to $100,000. You’ll have five years to repay the loan starting next year. If you don’t repay the loan in the five years, it will be considered a distribution and you’ll owe taxes on it.
• You could consider asking a family member for a loan. If you take this route, be sure to formalize the plan in writing with repayment terms so you both know the expectations. Having a written agreement will help avoid misunderstandings and maintain your relationship.

It’s a tough decision; seek professional advice

Deciding if an early 401(k) withdrawal is the right thing to do is a complex process. Please consult your financial advisor or tax professional on what might be best for your particular situation.

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