Managing Your Retirement Account and Taxes During Economic Uncertainty
In times of economic uncertainty, you might start to notice some alarming changes to your retirement account. It's usually unwise to panic and withdraw early, even if the temptation is strong.
Key Takeaways
- If you’re younger than 59.5 years old when you withdraw money from your IRA or 401(k), you will likely pay a 10% federal penalty and often an additional state penalty. You will also have to add those funds to your state and federal income when you file your taxes.
- Typically, money you withdraw from a Roth IRA during retirement isn’t taxed and is free from penalty. But, if you converted a traditional IRA to a Roth IRA less than five years ago, you can be taxed and penalized when you withdraw that money.
- A 401(k) loan can be a good source of cash for the short term. This kind of loan isn’t taxable when you take the loan out. It won’t cause you to pay more taxes in retirement, provided you meet the repayment rules.
You have options
Are you beginning to notice drastic changes to your retirement account savings? When the market swings up or down, investors tend to make short-term decisions for their long-term retirement investments. This sometimes includes withdrawing money from their tax deferred retirement accounts. They might not be considering all the tax and financial impacts. You might want to resist that urge. We have the scoop on taxes now and in retirement. We cover what you can consider and what you might want to avoid doing when economic times are bad.
Early 401(k) or IRA withdrawals
If you’re under the age of 59.5, withdrawing money from your IRA or 401(k) will likely cost you a 10% federal penalty and often an additional state penalty. On top of that, you have to pay taxes on all the contributions and gains that you withdraw.
For example, if you took a $50,000 early withdrawal, it would likely cost you a $5,000 penalty on your federal taxes. You also have to include it in your state income when you file your taxes. It usually doesn't make good financial sense.
Early Roth IRA withdrawals
Generally, the money that you've contributed to a Roth IRA can be taken out at any time. This money isn't taxed and is typically free from penalty. If you need cash right now, withdrawing the money you've contributed might be a good option for you.
If you withdraw funds from your Roth IRA that were earned through investments, then you would likely pay taxes and penalties on that money. Moreover, if you converted money from a traditional IRA into a Roth IRA, you can be taxed and penalized for withdrawing it. This is true if the conversion happened fewer than five years ago.
TurboTax Tip:
Stopping your current 401(k) contributions can cost you in the long run. You will have less money when you retire. You might also miss out on any employer-matching 401(k) contributions.
401(k) loans
If you need cash now and know that you can pay it back, then taking a loan from your 401(k) might be a good choice for you. If you repay the loan on schedule, it will likely have little effect on your retirement savings overall. Since you'll repay a 401(k) loan with after-tax dollars, you'll lose some of the loan amount to income taxes. This is usually a small amount, especially compared to other types of loans, like bank and personal loans.
Stopping 401(k) payments
Like withdrawing funds early, you might be tempted to stop your current 401(k) contributions. Even if you could use that money elsewhere, you're taking money out of your pocket from the long-term to deal with a short-term situation. This is especially true if you'll be missing out on employer-matching contributions.
If you need more cash now, it would likely be better to take a loan from your 401(k) rather than to stop contributions.
Selling investments
Watching your retirement savings go down may make you feel like you need to sell investments. But, think again. The stock market has historically risen and fallen over time. So, even when the market goes down, historically it rebounds and continues to climb higher on a long-term basis.
Financial advisers learned from the 2008 stock market crash that investors did better if they kept their money in their investments. Many of them did better than those who sold their investments. This is because the average investor can't predict the best time to sell or to buy. It's often better to leave the money in a good investment and wait for the market to make its rebound.
Adding to your investments
This may seem like a strange idea to some, but when the market goes down, it could be a great time to buy stocks or other investments. If you have the money to invest when stock prices are low, it could be profitable when and if they rebound.
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