Options to Help Participants Avoid Tapping Into Retirement Savings

Plan sponsors can share with participants other options to consider before taking a DC plan loan or withdrawal.

The Coronavirus Aid, Relief and Economic Security (CARES) Act allows qualified individuals to take a loan or withdrawal of up to $100,000 from their defined contribution (DC) account, yet experts say DC plan participants should view this as a last resort.

Those affected by COVID-19—meaning those who have been diagnosed with COVID-19, have had a spouse or dependent fall ill as a result of the coronavirus or experienced adverse financial effects for a number of reasons—are eligible to take a coronavirus-related distribution (CRD) from their DC plan. The idea behind the enhanced distribution option was to provide a financial safety net to individuals with few options.

However, retirement industry experts encourage individuals to weigh the pros and cons of taking CRDs from retirement savings accounts. Many experts say cons include the three-year time window participants have to pay back the distributions to avoid incurring taxes and any taxation should an individual fail to pay back the distribution.

It’s best to tap into other networks before applying for a loan or withdrawal, says Ben Lewis, head of institutional sales and consultant relations at TIAA. “We say, ‘Let’s go back to basics.’ Are there ways to reduce credit card debt, utility bills, mortgages or rent?” he asks. Making a temporary lifestyle change, such as selling a car or unneeded furniture, can help with day-to-day cash flow troubles, he adds.

Lewis says taking a retirement plan loan should be a last-case scenario. Participants who take a large loan can risk not meeting the payback period, and many participants are already underfunded in their retirement programs, he says.

Individuals can instead source cash through a home equity loan, adds Mark Charnet, founder and CEO of American Prosperity Group. With such a loan, homeowners can borrow up to $100,000—the same as the CARES Act limit—and pay it back within 15 to 20 years with no major tax hit. Charnet recommends individuals look into lending from their local bank, as a bank in an individual’s state and region could be more likely to lend the money and it could result in a better value.

Similarly to using a home equity loan, homeowners can also refinance their home, Charnet says. Individuals who choose to refinance their loan can pay it back within 30 years at a lower interest rate than the one on the current mortgage. Homeowners can also choose a 15- to 20-year mortgage if they’re looking for a shorter payback period.

If an individual is not a homeowner but is still working, he may be able to get a loan from his employer or take a loan against his life insurance. Taking a loan from an employer often requires an employee to have good standing and other requirements, and individuals should check with their employer about specifics. In this scenario, employees could likely pay back the loan via a salary reduction, Charnet says.

Borrowing against a life insurance policy also may be a good alternative for those in urgent need of cash, Charnet says. Individuals can repay their life insurance loan on their own schedule and these loans will typically have low interest rates. However, an individual will need to have enough cash value in their policy for them to borrow. This may not be available for some participants, depending on how long they’ve had the policy.

Lewis and Charnet say these resources may not be realistic for some, depending on their employment status. Obtaining a home equity loan, for example, may prove more difficult for those who have lost their job, Charnet says. “It’s not an easy spot if you don’t have something to sell or equity to tap into,” he says.

Aside from selling unused items, individuals can free up some cash by reducing student loan debt payments and/or credit card debt payments. “It’s looking around and seeing where those opportunities are to pause, stop or defer debt payments, or take withdrawals separate and distinct from the retirement program,” Lewis says.

Through the CARES Act, individuals are allowed to suspend monthly student loan payments without penalty. Acting on President Donald Trump’s presidential memorandum signed August 8, U.S. Secretary of Education Betsy DeVos directed Federal Student Aid (FSA) to extend this student loan relief to borrowers through December 31. However, as Congress has reached a standstill on a new relief program, individuals who use this feature will need to go back to paying their loans after December 31.

Charnet also says that before taking a DC plan withdrawal, depending on how much money they need, individuals can look into possibly working a part-time job. This is more of a long-term plan, as it won’t generate a large sum of money instantly, and employers may be more reluctant to hire right now amid the pandemic and soaring unemployment numbers. But, if time isn’t critical, it can mean extra cash for those who need it for a medical bill or loan, Charnet says. “While it may not solve their immediate need, for something with a long time frame, they can certainly pay it back by earning a small income,” he says.