When times are tough, is it worth it to cash out your retirement?

With tough economic times ahead for countless Americans, the new CARES Act allows individuals under age 59 ½ to pull money from retirement accounts without the traditional 10% early withdrawal penalty.

If you are struggling to pay off credit card or medical debts, this may seem like a good opportunity to pay off creditors and regain a sense of financial stability. However, tapping retirement savings early to solve problems in the short term could ultimately have negative consequences down the road.

Why not dip into retirement savings?

Financial advisors generally recommend avoiding cashing out retirement accounts prematurely except as a last resort. In addition to potentially jeopardizing your ability to support yourself and family when you do retire, withdrawing funds early could mean missing out on the long-term benefits of compound interest. That is especially true if you cash out investments when the market is low.

Additionally, while you may be able to avoid the 10% penalty for early withdrawal under the CARES Act, you will still be responsible for paying income tax on the amount you cash in. The act allows you to distribute that tax burden over a three-year period, but ultimately you will have to make sure you have funds available.

Is filing for bankruptcy really a better option?

If you have overwhelming credit card payments, medical bills, payday loans or other types of unsecured debt, filing for bankruptcy may be a better option than draining a retirement fund. Bankruptcy generally eliminates these types of debt permanently.

More importantly, nearly all ERISA-qualified pension plan funds and retirement accounts are exempt from liquidation or garnishment under either Chapter 7 or Chapter 13 bankruptcy, including:

  • 401(k)s and 403(b)s
  • Roth, SIMPLE and SEP IRAs
  • Keogh plans
  • Profit-sharing and defined-benefit plans
  • Money purchase plans

Like many Americans, you may worry that filing for bankruptcy will ruin your credit for life. While it is true that filing will affect your credit score temporarily, you may actually be in a better position to rebuild your credit after discharging unsecured debt than you would be if you let that debt continue to grow.