Lack of money ? Here’s why you shouldn’t touch your 401 (k)

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The coronavirus pandemic has disrupted the personal finances of millions of workers and their families. And a recent trend is of particular concern.

Many workers who have been on leave or made redundant are now strapped for cash. And they are considering borrowing money from their 401 (k) instead of using other sources of funds.

Advisors recommend tapping all other sources of money before borrowing on your 401 (k).

“Please avoid retirement accounts,” says Chris Chen, a certified financial planner at Insight Financial Strategists. “The long-term damage is absolutely horrendous. “

The economic crisis caused by the coronavirus pandemic, which is shutting down businesses and forcing millions of people out of work, makes it even less attractive.

“We like to use 401 (k) loans as a last resort, especially in a tough financial environment,” says Dan Galli, Certified Financial Planner at Daniel J. Galli & Associates.

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Reason to avoid 401 (k) loans

Galli also advises against 401 (k) loans for this reason:

Plan sponsors, according to the IRS, can require an employee to repay the entire outstanding loan balance if they terminate employment or if the plan is terminated. And it could put even more financial strain on your finances if you’re already desperate for living expenses.

Worse yet: if you, the employee, are unable to repay the loan, your employer will treat it as a distribution and report it to the IRS.

“The country is littered with stories of people who have made 401 (k) withdrawals on every repayment attempt, but never made it,” said Charles Sachs, certified financial planner at Kaufman Rossin Wealth. “Imagine the growth lost over a period of 20, 30 or 40 years. If people think they are struggling now, they should imagine when they are 80 without the benefit of a good sized 401 (k). “

The good news: You, the employee, can avoid immediate tax consequences by transferring all or part of the outstanding loan balance to an IRA or qualifying retirement plan before the due date for filing the tax return. federal for the year. in which the loan is treated as a distribution.

What to type instead

So where could you find the money for your living expenses? Well, for starters, consider that each option has its pros and cons.

But overall, family loans, a home equity line of credit, and credit cards should be used before borrowing from a 401 (k), Galli says.

Thomas Scanlon, a certified financial planner at Raymond James, also recommends using your Roth IRA.

“Your Roth IRA contributions can be withdrawn at any time, with no income tax or penalty,” he says. “This is because the contributions are made after tax.”

If you’re eligible for a refund, file your 2019 tax return immediately. That’s another source of money, says Rita Cheng, Blue Ocean Global Wealth Certified Financial Planner. Likewise, follow up on your dunning check if you haven’t received it yet.

And, for some, accessing the cash value of your life insurance is another source of funds, Cheng says.

You may be able to take a hardship distribution from your 401 (k) plan. As a general rule, it is authorized for an immediate and significant financial need, and limited to the amount necessary to satisfy that financial need. But experts generally advise against this tactic. This is because you will have to pay distribution taxes, and you cannot repay the distribution in your 401 (k).

The bottom line: List all of your available options and create a plan that will best weather a tough storm, says David Mullins, a certified financial planner with the David Mullins Wealth Management Group.

When a 401 (k) loan is the best option

To be fair, a 401 (k) loan may be the best option, depending on expected need and duration, and what other options are available. But remember, “you are withdrawing funds in a bear market and missing out on a potential recovery,” says David Shotwell, a Certified Shotwell Rutter Baer financial planner. “It may be less costly in interest, but the cost in the long run may be much higher. bigger.”

The right way and the wrong way: If you are borrowing money from your 401 (k) plan, there are some best practices to follow. When you take out a loan, you are selling securities, says Léon LaBrecque, a certified financial planner at Sequoia Financial Advisors. And given that, Robert Braglia, a certified financial planner with American Financial & Tax Strategies, advises against taking the money pro rata from all investment options, but rather specifies which ones, likely cash or bonds, will be sold.

The law on care: According to Ed Slott, CPA at Ed Slott and Company, the CARES Act increases the maximum loan amount for qualified individuals to the lesser of $ 100,000 (reduced by other outstanding loans) or 100% of the account balance, and, second, allows qualified individuals to take up to $ 100,000 in distributions without penalty from IRA and coronavirus-related business plans during 2020. If you are a qualified person, the loan or distribution could be a source of funds for living expenses.

Robert Powell is the editor of TheStreet’s Retirement Daily (www.thestreet.com/retirement-daily) and a regular contributor to USA TODAY. Do you have questions about money? Email Bob at [email protected]

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