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How to Keep Employees from Raiding Retirement Funds

The COVID-19 pandemic has wreaked havoc upon the finances of many employees, and some have been forced to use funds from their retirement plans.

A spokesman for Betterment for Business, which offers 401(k) plans, pointed out that retirement savings plans represent the bulk of what most Americans have saved, and, in some cases, is all they have saved.

Fortunately, your employees’ only recourse for emergency cash for housing, food or medical costs does not need to be their retirement plan. There are a number of other sources of cash and — employers can help.

Why Retirement Funds are Not the Answer

First, it’s important to point out the pitfalls of using retirement funds before retirement.

  • Penalties: Anyone who withdraws money before age 59½ will have to pay a 10 percent penalty on money withdrawn. Exceptions to that rule are if the individual is totally and permanently disabled, has significant medical expenses; uses the money for higher education; or uses the money to pay for health insurance when unemployed. Also, see the section “If All Else Fails” at the end of this article.
  • Income tax: Withdrawals will be treated as taxable income, and if your employee withdraws a significant amount at once, the additional income could push them into a higher tax bracket. They could end up paying a tax rate of 25 percent or more and lose the benefit of some credits and deductions.
  • Compound interest: Interest can really help build an employee’s retirement fund. For example, if a forty-year-old employee places just $10,000 into an account that earns 6 percent interest, when they retire in 25 years, they will have $42,919 at age 65. If they wait only ten years, however, until age 50, their $10,000 investment will be worth only $23,966. Taking money out of retirement funds is like starting over.
  • Legal protections: Employees facing financial difficulties with creditors should know that creditors can’t touch retirement accounts. That’s why a financial crisis is not usually a good time to drain retirement accounts.
  • A better retirement: Too many people are not saving enough for retirement. The Consumer Federation of America and the American Savings Education Council found that only 49 percent of non-retired respondents think they are saving enough for retirement. Withdrawing funds for emergencies leaves less for retirement.

What Employers Can Do

Taking these actions could make financial life easier for employees:

  • Employer-sponsored loans: Work with your financial institution to make loans available as low-cost alternatives to credit cards. Many financial institutions are offering loans with three-month deferments so people can wait until the pandemic crisis ends to pay them back.
  • Employee hardship fund: If you have an employee hardship fund, can the application process and funding timeline be shortened to allow employees to receive the funds more quickly?
  • Health Savings Account (HSA) contribution: If you are financially sound, you might want to make a one-time contribution to your employees’ HSA or retirement accounts.
  • Changes in salary deferral elections: Employees should be informed that they can elect to reduce or cancel their salary deferral elections to put more money in their paychecks (as taxable compensation) if they have a coronavirus-related need.

If All Else Fails

If employees must use their retirement savings for emergency purposes, they should know that Congress outlined new rules for retirement fund withdrawals in the CARES Act. Individuals can take penalty-free withdrawals up to the full amount of the 401(k) or $100,000, whichever is the lower amount, for a coronavirus-related distribution. The distribution is taxable income but may be spread over 3 years to reduce the tax impact. Required Minimum Distributions are also suspended for 2020. Under the CARES Act, a ‘coronavirus-related distribution’ is a distribution to a taxpayer who:

  • Is officially diagnosed with the SARS-CoV-2 virus
  • Has coronavirus disease (COVID-19)
  • Has a spouse or dependent who is diagnosed with such virus or disease
  • Who experiences adverse financial consequences, such as being quarantined, furloughed, laid off or having work hours reduced, being unable to work (or telework) due to lack of child care, and the closing of a business or reduction of hours of an individual who owned or operated the business, in each case due to the virus or disease.

Employers may accept an employee’s certification that a coronavirus-related distribution is necessary.