Investment Opportunities

Should You Withdraw From Your 401(k)?

For reasons that I still don’t entirely understand, when I turned 40, I decided that I would become a runner.

Not a casual runner. Not running just to get some exercise.

I didn’t even want to run just a marathon.

My goal was to become an ultramarathoner. Ultramarathons are races that are longer than a marathon (typically 50 kilometers or longer) and take place over difficult terrain.

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Here I am at one of the best moments of my life, receiving my finisher Lost Soul “rock” for completing 100 kilometers. My kids were actually proud of me!

It is an absurd hobby. I’ve done six so far, and they just keep getting longer and harder.

A big part of the reason that I’m able to finish these races is that I run with a partner (though now from a distance). Getting in shape for these things takes endless hours of running, and I’m not sure I could stay motivated to do it by myself.

These days, our conversations as we run are focused on my training partner’s small business. She owns a very successful hair salon that employs more than 20 people. And as you would suspect, the pandemic has put her in a tough spot.

I have the utmost respect for this woman’s work ethic. She works six days a week, 51 weeks per year. It’s no wonder that she is a great ultramarathoner – she is a machine.

But social distancing and a hair salon are not a match. You can’t cut hair from a meter away. For society, closing the doors on small businesses like hers is the right thing to do.

But it puts her in a dire situation.

Open or closed, small businesses like hers have bills that need to be paid, like rent, property taxes, electricity and water fees, and interest and principal payments on loans. And that doesn’t factor in the money that she needs to live.

On top of all of this is the stress she has from having to send her employees home. That’s 20 more people with no income.

The worst part is that we have no idea how long businesses are going to remain shut. Two weeks? Two months? Maybe longer?

Much of our time running is now spent brainstorming how she can navigate through this and where she can turn for cash – a question many people are confronted with today.

So for her, and for the many Americans who are also considering where their short-term cash needs will come from, I’d like to address a common question…

Should you withdraw from your 401(k)?

The Coronavirus Stimulus Package and Your 401(k)

The $2 trillion CARES (Coronavirus Aid, Relief and Economic Security) Act that President Trump just signed includes a provision that allows you to withdraw early from your 401(k) without getting hit with taxes or penalties this year.

In a normal year, if you made a withdrawal before the age of 59 1/2, you would get hit with a 10% penalty on the amount you withdrew plus would have to pay income tax.

So in a normal year, withdrawing from your 401(k) should be avoided.

But this is not a normal year.

In 2020, you can pull up to $100,000 out of your 401(k) without paying a penalty. All you need to do is show your retirement plan operator that you are facing “adverse financial consequences” as a result of the coronavirus.

You will still have to pay taxes on the withdrawal, but those aren’t due for three years and can be avoided if you are able to pay the money back before then.

So should Americans like my training partner take advantage of this unusual offer?

Truth is, there’s no right answer that is applicable for everyone. It depends on your unique situation.

If you have other options for short-term cash, such as cashing in a certificate of deposit (CD), using your rainy day fund or tapping into a low-interest home equity line of credit, I would advise doing that.

Your 401(k) is for your retirement – and if possible, you should avoid going there. You want that money invested and compounding for as long as possible.

The best-case scenario that would make tapping into your 401(k) this year a financially responsible decision is if you expect that you will be able to repay those funds within three years.

If you can do that, you will not have to pay tax on the withdrawal, and you will have essentially received a three-year interest-free loan. No harm, no foul.

The reality, though, is that the next several months are going to be incredibly difficult for millions of Americans.

Avoiding pulling money from your 401(k) would be great, but given that more than 3 million people filed for unemployment during the week ending March 21 alone (five times the all-time high), it is clear that a lot of folks aren’t going to have many options.

As a last resort, I believe these 401(k) “hardship distributions” will be a lifeline and a reasonable option for those who are hit hardest by what is happening today. Hopefully, if you have to take that option, you will be able to repay the money as soon as possible.

Right now, my training partner and I are getting ready for the Canadian Death Race, which is scheduled to take place in early August in the Canadian Rockies. It features grizzly bears, cougars and three mountain peaks.

We are hopeful that the world has the pandemic under control by then.

Until then, all of us in society need to take an “ultra” mindset. That involves putting our heads down and focusing on doing what needs to be done until we get to the finish.

It is going to hurt for a while, but we will get there together – and hopefully sooner than expected.

Good investing,

Jody


About

Jody Chudley is a Contributing Analyst to Wealthy Retirement. He is a qualified accountant with two decades of experience in the international banking and hedge fund industries as a financial analyst.
His background in finance has made him an expert in deciphering financial statements and uncovering deep value and income opportunities. He has written for various websites and financial magazines with a focus on the resource sector and contrarian investment opportunities.

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