When you're unemployed, out of savings, and your unemployment check doesn’t cover the bills, you may need another place to turn for money. Depending on your situation, you may be able to withdraw money from a 401(k) or ask your parents for a loan. While neither option is ideal, here are some considerations to help you decide.
- You can withdraw up to $50,000 from your 401(k), but you will owe interest and could owe taxes depending on when you pack it back.
- If you have a Roth IRA, you can withdraw your contributions at any time without tax or penalty.
- If you borrow from your parents, it's best to have a formal, written agreement that details the terms of the agreement.
You don’t want to take on expensive credit card debt. You can’t get a loan when you don’t have an income. So do you sacrifice your future and withdraw from the 401(k) plan you had at your last job? Or do you swallow your pride and ask Mom and Dad or another relative for a loan?
On March 27, 2020, President Trump signed into law a $2 trillion coronavirus emergency stimulus package called the CARES (Coronavirus Aid, Relief, and Economic Security) Act. It expands unemployment insurance eligibility to gig and freelance workers and part-time workers who have been affected by the coronavirus.
Your parents might be the type who are willing to help you in any way they can. Still, think twice before accepting their generosity.
“The most important thing to consider is where the money your parents are giving you is coming from,” says Misty Lynch, a financial consultant with John Hancock. “If they are wealthy and offer to help you out of cash flow or savings, that could be a good option, since any distribution you make from your 401(k) will be subject to taxes and penalties. You can repay them and start contributing to your retirement savings when you get back on your feet.”
What you don’t want is for your parents to lend you money that’s meant for their retirement. “If they spend down their retirement assets,” says Lynch, “they might not have any time to build them back up. Working into their 70s or 80s might be really difficult, and they might be forced to rely on you to help them out financially in the future. If you don’t want Mom and Dad living with you someday, it’s better to take the distribution from your own assets and make saving a priority when you get back to work.”
Borrow From Your Parents
Let’s say your parents can comfortably help you out. Borrowing money from family is still tricky. It could damage your relationship if you don’t repay the loan on time, especially if your parents don’t agree with how you’re spending the money or conducting your job search.
Experts say you can minimize potential conflicts and prove you’re serious about repayment by spelling out expectations upfront in a formal, written contract. “The child should also pay interest to the parents, similar to what they would pay for borrowing from their 401(k),” says Ashley M. Micciche, CEO and retirement plan specialist with True North Retirement Advisors in Clackamas, Ore. “Prime plus 2% is a good starting point.”
Other details, such as the repayment period and the amount of each monthly payment, should also be in writing, she says. The challenge is that the child may have no means of making loan payments right away. “The best option here could be to allow the child to defer payments until they find employment, while the loan accrues interest—which should help incentivize the child to find work soon,” says Micciche.
Dennis LaVoy, a financial advisor with Telos Financial in Plymouth, Mich., adds that discussing your short-term plan to find another job and decreasing your expenses as much as possible so your parents don’t feel you’re spending frivolously can mitigate family tension.
Get Money From Your 401(k)
You can withdraw up to $50,000 from your 401(k)—$100,000 in 2020 due to the CARES Act during the coronavirus outbreak. Normally, you would owe a 10% penalty in addition to taxes on your withdrawal if you are younger than 59½. But during the CARES Act period, early withdrawal penalties are suspended. Be sure to check with the plan's 401(k) administrator to find out the rules.
Withdrawals from any retirement account of course risk damage to your long-term financial health. If a 401(k) withdrawal is your best or only option, how can you minimize the financial damage from the lost investment opportunity and early withdrawal penalties?
First, keep taxes in mind. If you’ve already earned substantial income for the year, see if you can wait until next year to make a withdrawal, or at least limit your withdrawal to the bare minimum you will need to meet your essential living expenses for the rest of the current year.
Of course, next year you may become reemployed and still owe substantial taxes on any 401(k) withdrawal, so always minimizing your early withdrawals is a sound strategy. One additional help from the CARES Act: Instead of owing taxes on your withdrawal the year you take it, you have up to three years to pay the taxes due on money withdrawn in 2020 due to the coronavirus outbreak.
Second, consider alternative sources of funds. “If you have a Roth 401(k), you can take out your contributions—not the earnings on the investments—at any time without tax or penalty,” says Maggie Johndrow, a financial advisor with the Johndrow Wealth Group of Farmington River Financial in Farmington, Conn. Similarly, if you have a Roth IRA, you can withdraw contributions without penalty.
Third, keep the setback to your 401(k) balance in mind when job hunting. “I would suggest finding a job—or negotiating this when offered a job—that has a 401(k) that includes a high employer 401(k) match. This may help rebuild retirement savings,” Johndrow says. She also recommends contributing beyond the minimum required to get the employer match once you’re working again and funding an additional retirement account, such as an IRA, to offset some of the retirement savings you withdrew while unemployed.
The Bottom Line
“If the child is a responsible adult and has fallen on hard times, and this is not a recurring issue, then I would go to the parents for a loan and set up a payback plan in writing,” Micciche says. “The long-term impact of a withdrawal from a retirement account is very damaging, especially when it’s someone in their 20s and 30s.”
For someone 30 years from retirement, a $10,000 withdrawal that would have grown by 8% per year means a sacrifice in retirement savings of more than $100,000. Also, as Johndrow points out, “You can borrow for almost anything in life—school, car, house—but you can’t borrow for your retirement.”
That goes for both you and your parents. However, you probably have more years to make up for lost ground than they do. A loan from your parents isn’t a bad idea, but you should take it only if they can afford it and you will repay the loan as agreed.