Should You Use Your Retirement Accounts to Pay Bills?

MARK RIEPE: In late March of 2020, legislation was passed that makes it easier for individuals to access money that’s locked away in their retirement accounts. The factors that determine whether you should use your retirement accounts to support current expenses is the subject of this episode.

But before we explore that, let’s go back to April 17, 1999. This date was important for the then head coach of the New Orleans Saints, Mike Ditka. The Saints are a team in the National Football League, and they’d won six games and lost 10 in each of the past two seasons. The NFL’s draft for new players was taking place on April 17, and this was their chance to upgrade their roster. In the weeks leading up to the draft, Ditka had his sights set on one player, University of Texas running back Ricky Williams. Earlier in his coaching career, when he led the Chicago Bears, Ditka got to see firsthand the impact that a powerful running back could have on a team.

Those Bears had as their primary rusher future Hall of Famer Walter Payton. Ditka saw glimmers of Payton in the young Ricky Williams, but Ditka and the Saints faced a common dilemma that we all face at some point: How do we fix a big short-term problem? In this case, they had a lousy team that they wanted to upgrade right now, and they felt a player of Williams’ caliber could make them immediately better. The problem was they didn’t hold an early enough draft pick to get Williams where he was likely to be chosen. Their solution? The Saints traded all six of their draft picks from the 1999 draft, plus two picks from the 2000 draft, to the Washington Redskins. In return, they got one very high draft pick, and they used that to select the running back they so coveted.

If you’re not a football fan, the essence of this deal is that the Saints gave up the right to acquire eight players over the next two years to select one player. The Saints were, in effect, sacrificing much of their future in the hopes of solving a short-term problem. This was a huge risk. In fact, in the 80-year history of the NFL up to that point, no team had ever done a deal like it. With the benefit of hindsight, that tradeoff wasn’t worth it. Williams struggled with injuries, and the Saints actually got worse in his first season. They finished 3 and 13 that year, their second worst in team history. Ditka and everyone else on the coaching staff was fired, as was the team’s general manager. As for Ricky Williams, he stayed with the Saints for two more seasons, and then he was traded to the Miami Dolphins for, you guessed it, future draft picks.

We see this risky sacrificing of long-term success for short-term gains in sports all the time. In the early 1980s, Ted Stepien was the owner of the Cleveland Cavaliers in the National Basketball Association. In one five-month flurry, he traded away the team’s first round picks for the 1983, 1984, ’85, and ’86 drafts. The players they acquired for those draft picks didn’t produce, which meant that the team was one of the worst in the league. And the lack of future draft picks made it difficult for the Cavaliers to get better. It took them years to recover from these deals and build a winning team.

We’ve talked on this show many times about putting in place guardrails to prevent ourselves from making poor decisions driven by emotional and cognitive biases. The NBA, in fact, did that very thing after the Stepien fiasco. The league implemented rules that blocked teams from trading away their first round draft picks in consecutive years. In essence, the league decided that owners couldn’t be trusted to always make good decisions when it came to balancing the desire to win right now, with the need to have a competitive franchise in the future.

When teams or even companies are desperate for a short-term solution, they can make tradeoffs that haunt them for years. The same is true with individual investors.

I’m Mark Riepe, and this is Financial Decoder, an original podcast from Charles Schwab. It’s a show about financial decision-making and the cognitive and emotional biases that can cloud our judgment.

As we’ve discussed on prior episodes, the federal government has created various types of retirement accounts for individuals. Policymakers understand that most of us are all too willing to sacrifice our long-term wellbeing for the purpose of immediate gain. They’ve created incentives like tax deferrals to contribute to these accounts, but also put up barriers to deter us from pulling out the money too soon. They know that without these barriers, many people will be tempted to use retirement accounts as a quick fix to solve short-term problems. However, recent legislation has done away with some of those barriers. That legislation is well-intended. Many people are facing financial difficulties as a consequence of our fight against the COVID-19 virus.

Today, we’re going to talk about what to do when you’re short on cash. In other words, we’re going to answer the question, should you use your retirement savings to pay for short-term bills?

I’m joined now by Rob Williams. Rob is a vice president here at the Schwab Center for Financial Research, and he focuses on financial planning and retirement issues. Rob’s been on the show before. Back in Season 1, he was on a couple of episodes. One was talking about when you should take Social Security, and another episode about the importance of financial planning. And then, Rob, I think you were on last season, as well, talking about New Year’s resolutions. So if you go to schwab.com/Insights, you can see a lot more of Rob’s work, and in my opinion, the material pertaining to retirement is especially good. So Rob, welcome.

ROB WILLIAMS: Hi, Mark. Great to be here.

MARK: Rob, the recently passed CARES Act allows me to withdraw money early from retirement savings accounts if I need to because of COVID-19. Should I do that right now? And then setting aside the CARES Act provisions, does that ever make sense?

ROB: Well, Mark, I think we should start just by saying how challenging this has been for a lot of people in terms of their finances, their wealth, their health, their stress. And there’s a lot of things in finance that we probably shouldn’t do—you know, shouldn’t spend all of our savings, etc.—and we can talk a little bit about that. But you know, generally speaking, just because you can withdraw money from your retirement accounts doesn’t mean you should. So I think that’s something we should talk about a little bit more.

MARK: Yeah, I get that. That makes a lot of sense to me as a general principle, and that’s certainly our usual advice. But is there anything different about right now, given the unusual economic situation we find ourselves in?

ROB: Well, there’s a lot unusual about the economic situation, perhaps, but from a planning perspective, you know, it’s really important to look at sort of have you prepared for these financial hardships? And the good news is that the CARES Act was passed by Congress as a short-term relief to help for those, you know, who just weren’t prepared for this, or who just can’t anticipate a health event like this. And it’s called the Coronavirus Aid Relief and Economic Security package for a reason. It’s there to provide some relief to investors who have retirement accounts and really who do need it to take early withdrawals or loans in case of financial hardship.

MARK: So let’s talk about some of those rules more specifically. What are they exactly? What does the CARES Act allow you to do that you maybe couldn’t do before?

ROB: Well, I think it’s important to think about what were the rules before? So previously, the IRS, if you had a 401(k), you have an IRA, individual retirement account, if you took money out early, which is before the IRS thinks is the earliest retirement date, and the rules are 59½. So if you’re younger than age 59½, you would pay a 10% penalty, along with taxes, to the IRS for what’s called an early withdrawal. There’s some exceptions to that, but the big one in the CARES Act is that it waives that penalty, most importantly, for anyone who had a COVID-19-related event.

MARK: So in other words, before the CARES Act, if I was, let’s say, age 50, and I took out $100,000 from a retirement account, I would owe $10,000 in penalties, and now with the CARES Act, I don’t have to pay that. Is that right?

ROB: That’s right, exactly. You don’t pay that 10% penalty.

MARK: What other restrictions are there? What other fine print do people need to be aware of?

ROB: Well, the total amount across accounts can’t exceed $100,000. So you can’t withdraw more than that amount from the combination of any retirement accounts you have, a 401(k), an IRA. The key I’ve mentioned already, too, is that the withdrawal has to be to support an immediate financial need related to COVID-19. So it’s really important to have evidence of that from a CPA when you file your taxes. So it can’t be just for anything. And the last is you can contribute the amount back into your retirement account later, but it has to be within three years. That’s very important.

MARK: Do you have to pay it back within three years, or is that up to you?

ROB: No, you don’t have to pay it back, and that’s where I want to kind of shift gears a little bit. We’ve been talking about what you can do, but let’s talk about what maybe ... back to what you shouldn’t do if you can avoid it. You don’t have to pay it back. And that’s one of the challenges from a behavioral perspective, I think, is that when you don’t have to do something, we often don’t. So it’s really important, I think, to focus on whether you have an emergency, not to be, you know, too preachy about it, but make sure you can do whatever possible to pay that money back within that three-year time horizon.

MARK: Rob, we started out this episode talking about some examples from the sports worlds, where people, they made decisions, they were designed to solve a short-term problem, but what actually happened was they ended up creating a much larger long-term problem. So what are the downsides of taking money out, even if you plan to pay it back?

ROB: The biggest downside is you’re probably going to retire. You want to retire. That’s why you were saving. And the most significant risk is time out of the market, meaning you’re not invested in the market. So if you absolutely don’t have to take those funds out, don’t. It doesn’t have an opportunity to grow. And the other risk is, even if you’re well-intentioned and plan to pay it back, we know that many people don’t. So if you’re not forced to do something, sometimes we don’t. So those are two big ones.

MARK: Yeah. I think sometimes we forget that market recoveries, they tend to be front-loaded. In other words, they drop precipitously, but then when they start coming back, they can come back really quickly. Has that been the case in this crisis?

ROB: Yeah, that’s been exactly what’s happened in this market—and really in a profound and pretty amazing way. Think back to March. I guess March 23 was the bottom of the stock market. The S&P 500® was down 34%. Lots of concerns about quarantine, the economy shutting down. And then it’s recovered 45% since then, as of at least while we’re taping this podcast. It’s close to prior highs, not quite there. And this tends to be the case. I mean, these are unusual times, but a lot of recoveries tend to be front-loaded like that.

So it’s really hard to time. If you’re out of the market, you’re not going to participate in that rebound. And that’s really where you’re going to get that recovery. If you just are out of the market, you withdraw, and then you suddenly don’t recover, that’s going to put your long-term goals, your retirement, at risk.

MARK: And missing out on that … missing out on that recovery, that is, in effect, a cost, sort of an opportunity cost. And that can be … and that can end up being pretty large. And so I guess you should really ask yourself whether the way in which you’re going to be spending that money that you pull out of the account, is it really worth it, given the possibility that you’re going to forgo gains? Is that a good way of thinking about it?

ROB: Exactly. This is called an emergency withdrawal for a reason, and we can pivot a little bit to planning and some of the aspects of planning, and a lot of planning is about needs, wants, and wishes. Thinking about which is which for you. Now, clearly, a healthcare event, losing a job is a need, and there may be a need to pull from a retirement account. But I think it’s really important to think about other options first to see what … you know, maybe if you have other funds, we can talk about it, and either try to avoid that for things that aren’t needs, that aren’t truly an emergency.

MARK: Yeah, I think right now, as we’re recording this, the unemployment rate in the U.S. is about 15%. So there are definitely going to be some people who are going to need to take advantage of this program.

So what are some of the options, though, that they should consider before they start tapping into their retirement accounts?

ROB: Sure. Well, an emergency fund is a great place to start. We recommend that investors have three to six months in cash if they can, you know, before investing aggressively, certainly beyond the retirement accounts. So that’s a place to start. We don’t want events like this to happen, we don’t want these risks to occur, but we know that they do. So having that emergency fund saved in cash, maybe money market funds, is a place to start—tap that first.

MARK: Makes a lot of sense. It’s possible that some people may not have had an emergency find or maybe, given that we’re a few months into this, maybe they had one, but they’ve already exhausted that. What’s the next step? Where does, for example, cutting spending fit in?

ROB: Well, cutting spending, I think would be the first next step for sure. Again, needs, wants, and wishes is really important. What are the most essential items? You know, my son may have a different definition of what’s essential. I mean, he thinks his Nintendo games are essential. But as someone going through real challenges, it isn’t easy, but thinking about what those real important needs are and trying to cut back in other places and avoid tapping into those retirement accounts or things that are earmarked for other purposes is really important. It’s called a retirement account for a reason, and trying to keep it that way makes sense if you can, for sure.

MARK: Yeah, and a lot of people have, in addition to their retirement accounts, have got other forms of investment accounts. Would that be the next place to look?

ROB: Yes, I mean, for sure. If you have a taxable investment account, which just means a traditional brokerage account, that’s the place to go first. There’s a concept called mental accounting, and having money in a retirement account is a way of mentally saying, “This is for my retirement.” And there are reasons why they’re not intended to take money early. But a taxable investment account, a brokerage account, if you’re fortunate enough to have it, that’s the place to go next, and not … you know, not rely on those accounts that are for other purposes.

MARK: For those who own a home, what options do they have that may be not available to, for example, a renter?

ROB: Well, this may not sound like a fun option, but there’s a lot of forbearance options for those who need to delay payments on a mortgage. Now, I wouldn’t encourage necessarily going out of your way to do that, because, clearly, you’re going to have to pay those back. But beyond that, sort of less emergency is to have a home equity line of credit, called a HELOC. That’s a way to tap equity and pay it back for short-term needs. It can be kind of a support, too, in addition to your emergency fund. So that’s one thing to consider if you don’t have that already.

MARK: Setting individual financial goals with different time horizons, establishing priorities, those are all some of the, you know, basic, fundamental building blocks of financial planning that, you know, we’ve discussed in other episodes.

So maybe tell us a little bit more about that and how even though we couldn’t have really anticipated the outbreak of COVID-19, how does planning help you get through something, even if you didn’t anticipate the exact circumstances of the event?

ROB: Sure. Well, you know, we often think about planning as a way to achieve a long-term goal like retirement, and frankly, you know, it can get almost tiresome to be talking about things that are way off in the future. But beyond needs, wants, wishes, the other really important concept in planning is now versus later, and that’s definitely a psychological concept. Are we going to spend now, or are we going to spend later? It sounds simple, but we know it’s really difficult to do. So a core aspect of planning is saying, “Look, what’s my time horizon? Do I need to be saving for something in the future?” But to do that, it’s important to have what we call capacity, meaning “I need to have some cushion in place for those things we don’t think are going to happen but could happen now.” So emergency funds, things like that. It’s important to think about that time horizon and make sure you’ve got both covered if you can.

MARK: I think there are elements, also, there of just basic risk management, asking yourself, you know, what could go wrong and putting in place some kind of plan to deal with it, right?

ROB: Right. There’s two sides to planning. One is the investment side, the cash flow management, you know, the things that we focus on a lot at Schwab. And the other side that you focus on when you’re talking with a planner is the risk. What insurance do you have in place? Do you have an emergency fund? Do you have a good estate plan, a will in place? All those are things that are maybe not as fun to think about but are really important. And it helps us anticipate things that we don’t hope or think are going to happen, but they can. Easy to say now, but it’s a good reminder to try to be prepared for that going forward.

MARK: Rob, there’s going to be definitely some people who pull some money out of these retirement accounts, despite the existence of these alternatives that you just laid out. For people who do end up in that situation, what are some smart ways for them to catch up on their savings and replenish those accounts down the road, when things get back to, hopefully, normal?

ROB: Sure. Well, I’ll mention three. One is have a plan to pay it back, for sure. It may be difficult, it may be challenging, but do everything possible within three years to pay those funds back. They’re there for your retirement and to, hopefully, grow. The second, and this is as things recover, there are ways to sort of increase or step up your contributions to retirement accounts after age 50 and later. So that’s important to consider once things, you know, hopefully, stabilize, and the financial situation allows. And the last is get a retirement plan. Stress is a time to do something. And many of us say we have a retirement plan, but maybe don’t have the details. So we found when we talked to clients, a lot of them are very concerned. They just don’t know how to … “Have I saved enough?” So that’s a really important point. Go do a retirement plan, saying, “Am I on track? Is this withdrawal going to … is it going to hurt me? You know, what do I need to do to get back on track after this happens?” That’s a great step, and that’s what a retirement plan and talking with a financial planner can do to help.

MARK: That’s fantastic information. Great advice, Rob. Thanks for coming by today.

ROB: Thanks, Mark. Great to be here.

MARK: As Rob explained, there are certainly times when it makes sense to tap into retirement accounts to take care of true emergency expenses. But before you take that step, think hard about and take seriously the alternatives that he suggested. As you’re doing that, here are three tips to consider:

First, take the alternative seriously. Too often when presented with alternatives, we look at them in a cursory fashion and don’t really give them serious consideration. If you’re considering the option of tapping your retirement accounts early, put the burden of proof on not taking that step. In other words, force yourself to prove that pulling the money out early is truly superior to each and every one of the alternatives that Rob suggested.

Second, if it turns out that pulling some money out makes sense, think hard about the dollar amount you withdraw. Every dollar you withdraw now is a dollar that, in effect, is being pulled away from your future self. The only advocate for your future self is your current self, so make sure your future self gets a voice, and your current self doesn’t get more than you absolutely need.

Third, make a plan for getting your retirement savings back on track as soon as you can. As Rob explained, the new legislation offers some attractive terms to encourage replacing the money withdrawn as long as it happens within three years. It makes sense to take advantage of those terms, but the odds of that happening go up if a specific plan is created.

This is a complicated topic, and if you’re unsure what steps to take, we recommend talking to a financial advisor about your specific situation. An advisor might be able to help you identify other options to reduce these and tax liabilities, as well as helping you form a plan to get back on track.

If you would like to learn more about accessing guidance from a financial planner, check out schwab.com/IntelligentPremium. That’s schwab.com/IntelligentPremium.

That’s it for today, and thanks for listening. Please take a moment to subscribe so you don’t miss an episode. And if you like what you’ve heard, please leave us a review or rating on Apple Podcasts or your favorite listening app. Those ratings and reviews really do matter. And you can also follow me on Twitter @MarkRiepe, M-a-r-k-R-i-e-p-e.

For important disclosures, see the show notes and schwab.com/FinancialDecoder.