Some options to accessing money during these difficult times
Two sources of money that you may have access to, in these difficult times, are your retirement fund and equity in your home.
The federal government passed the CARES Act in March. This act made it easier for people to take early withdrawals and loans from retirement accounts. The intention of the act was to provide money now to people to pay their bills. This makes sense when their other alternatives could be credit cards and payday loans.
Making it easier to access your retirement money may make sense, but not giving guidance on the best way to do it could lead some people to make poor choices. And poor choices could diminish your financial security in the future.
The law temporarily waives the 10% penalty on early withdrawals for COVID-19 related reasons, and eliminates the taxes on such withdrawals if the money is paid back within three years. It doubles the maximum amount permitted for a loan to $100,000. And it allows you to borrow 100% of the account balance. The law also waives for 2020 the required minimum distribution for people older than age 72.
The first question an individual should ask is: Should I take a withdrawal or a loan? The withdrawal doesn’t have to be repaid. If it is repaid within three years, the taxes paid on it will be refunded. A loan must be repaid on a fixed schedule.
Though a withdrawal may seem easier at first glance, failure to repay within the first three years may be a problem. Retirement plans do not have automatic repayment plans. You will be required to send checks on a regular basis to repay the withdrawal.
Claiming the tax benefit for repaying COVID-19 withdrawals may require the assistance of a tax professional, as you will be seeking a credit for taxes you have already paid. If you are serious about repaying your retirement account, take a loan. Repayment is easier and you will have more time to pay it back.
The next question is: How much should you take? Don’t take too much. The process may be easy, but remember your expenses – like most people’s – should be less during the shutdown. Ask your employer how often it will allow you to take withdrawals or loans. If you can take multiple ones, wait until you need the money.
Also, if you do not take a loan or withdrawal, but reduce your contribution rate to your retirement plan, make sure you don’t miss any matching funds. It’s free money. Also, remember to increase your savings rate once this crisis has passed.
The decision to take or not take your RMD in 2020 is a simple question of whether you need the money. If you don’t need the money, let it grow so there will be more money when you may need it.
There are several ways to turn the equity in your home to money. The easiest ways are a home equity loan (HEL) or a home equity line of credit (HELOC). Using your home’s equity to secure a loan or a line of credit is an attractive, low-interest way to raise money. While there are slight differences between the two, both offer higher borrowing limits than unsecured personal loans.
When deciding whether to go with a HEL or a HELOC, you will need to think about several things. Do you need all the money now, or would you like to take the money as you need it? What length of time do you need to pay the money back?
Do you want a fixed or variable interest rate? What fees and penalties are you willing to accept? Will you want to make interest payments only, understanding this may result in a larger payment due in the future?
The demand for these products is at an all-time high, so don’t be surprised to find your lender busy. You may want to set up a HELOC now, so you are ready for the next crisis.
As always, ask a professional for advice.
Bob Hollick is a State Farm Insurance agent based in Washington.
To submit columns on financial planning, investing or business-related matters, email Rick Shrum at rshrum@observer-reporter.com.