Don't dip into your retirement savings — do this instead if you need quick cash

In October 2020, the unemployment rate fell to 6.9%, declining a percentage point from the previous month, and the number of unemployed persons dropped by 1.5 million to 11.1 million, according to the U.S. Bureau of Labor Statistics. While these numbers are an improvement from the summer’s record high, they’re still nearly twice pre-COVID-19 levels.

To provide assistance to Americans who lost their jobs during the pandemic, the government created the CARES Act, which included legislation designed to help those who were struggling financially. Part of the temporary legislation was designed to make it easier to withdraw money from retirement accounts such as a 401(k).

Under normal circumstances, you’d pay a 10% early withdrawal penalty if you take money out of a retirement account before you reach age 59.5. However, if you’ve been negatively impacted by the pandemic, the CARES Act allows you to take a penalty-free emergency withdrawal of up to $100,000.

3 reasons to never borrow from your retirement account

There are several reasons why you should never borrow from your 401(k) or a similar account to pay off debt or for other expenses. This is why:

1. It could lead to a substantial tax bill: The money you take will become taxable income, divided into thirds and assessed over the next three years. If you don’t set aside money from your distribution to pay taxes, you could owe the IRS a substantial tax bill when you file your returns. You are allowed to pay yourself back and amend your taxes, but the process could be complicated, requiring the help of a tax pro.
2. The value of your investments could've dropped: In addition, the volatile pandemic economy may have impacted the value of your investments. It’s possible that you’d be cashing out funds that have lost money during the pandemic. By leaving the funds untouched, you give your account a chance to potentially rebound with the market. For example, if you withdraw the maximum amount, that $100,000 could have grown to more than $162,000 over the next 10 years without additional contributions if the market provides a 5% return.
3. You'll have less cushion when you retire: And don’t forget that you are tapping into funds that you will need when you retire. Depending on the value of your savings, taking $100,000 could substantially reduce your future funds. You’ll need to work harder to replace your nest egg so you can retire as comfortably as possible.

A survey from Edelman Financial Engines found that 55% of Americans who took money from their retirement account due to the pandemic regretted it. And of those who wished they hadn’t made the withdrawal, 85% said it was because they didn’t understand the financial implications of their actions.

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Here's what you should do instead

Instead of landing among this remorseful group and deducting money from your future, you may want to consider other options, such as taking out a personal loan.

Personal loan interest rates are at record lows, and they can be used for virtually any reason, such as paying for emergency expenses, consolidating debt, funding a home improvement, or covering medical bills.

How to find the best personal loan rate

Before you apply, however, it’s good to understand what criteria lenders consider when making you an offer.

1. Credit score: Lenders look at borrowers’ credit or FICO score to helps assess their risk. Lenders offer the best rates to borrowers who have higher scores. A good credit score will range from 700 to 749, and an excellent score is 750 and above. A fair credit score ranges from 640 to 699, and while borrowers in this group may still be approved, they will likely pay a higher interest rate.

2. Credit history: Your credit history plays a factor in your credit score. This information includes your history of making on-time or late payments, the balances you owe, the length of any credit accounts you hold, the amount of new credit you’ve recently received, and the types of credit you have.

3. Debt-to-income ratio (DTI): Lenders will also assess your debt-to-income ratio. To determine your ratio, lenders add your total debt payments, such as credit card bills, auto notes, student loans, mortgage payments, and personal loans, and divide it by your gross monthly income. Lenders prefer borrowers who have a DTI of less than 40%. Before you apply, use a personal loan calculator to determine the monthly payment a personal loan would create. You can use this number to calculate your DTI and assess its impact on your budget.

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