If you lose your job or have other expenses due to the Coronavirus pandemic, should you dip into your 529 plan? Or, should you dip into your retirement plans?
First Things First
Before you tap into your savings to pay for living expenses, exhaust your other options:
- Reduce your expenses. Pause your student loan payments by using an unemployment deferment, an economic hardship deferment, a forbearance or an income-driven repayment plan. Increase the deductible on your homeowners and auto insurance policies. Cut your cable TV and cell phone plans. Refinance your mortgage to take advantage of the lower interest rates. Consider refinancing high-interest private student loans for a lower interest rate. Keep in mind refinancing federal loans into a private loan means a loss in many benefits – any possible federal forgiveness, income-driven repayment plans, generous deferments, the death and disability discharge, and more. Live below your means, and find creative ways to save money.
- Negotiate severance with your employer, including coverage of your health insurance or COBRA premiums for a period of time. Do this before signing a separation agreement.
- Apply for unemployment benefits.
- Continue your healthcare coverage with COBRA. If COBRA is not available to you ore you have exhausted your COBRA benefits, get your children covered under the Children’s Health Insurance Program (CHIP). You can also apply for healthcare coverage through Medicaid or the health care exchange programs.
- Apply for Temporary Assistance for Needy Families (TANF).
- Your children may be eligible for the Free and Reduced Price School Lunch program. Even though schools are closed in many states, the schools are still finding a way to deliver the meals to children in need.
- Apply for the Supplemental Nutrition Assistance Program (SNAP), formerly known as food stamps. If your children are under age five, consider also the Special Supplemental Nutrition Program for Women, Infants and Children (WIC).
- Look for part-time work opportunities on web sites like Upwork, Fiverr and TaskRabbit.
There is no shame in using these benefits. They are like an insurance program, and you’ve been paying the premiums through your payroll taxes. These programs will let you delay the need to tap you’re your college and retirement savings.
Using College Savings vs. Retirement Savings
Before you consider taking a distribution from your 529 college savings plan or retirement plan, use your short-term savings. If you have an emergency fund or rainy-day fund, use it. Also use money in taxable bank and brokerage accounts.
Tap into your retirement plan accounts before using your college savings plan money.
- A return of contributions from a Roth IRA is tax and penalty-free.
- Hardship distributions may let you take a penalty-free distribution from your 401(k) or 403(b) retirement plan for an immediate and heavy financial need.
- You may be able to borrow money from your 401(k), 403(b) or government retirement plan with a repayment term of up to five years.
College savings plans, on the other hand, do not have penalty waivers for economic hardship or unemployment.
Non-qualified distributions from a college savings plan are subject to income tax and a 10% tax penalty on the earnings portion of the distribution. There are several penalty waivers that let you avoid the 10% tax penalty (but not the income tax).
- The tax penalty is waived up to the amount of certain types of educational assistance received by the student, such as scholarships, military service academies, AOTC, LLTC, veterans educational assistance, and employer-paid education assistance.
- The tax penalty may also be waived when the beneficiary dies or becomes disabled. The disability must be expected to result in death or to be of long-continued and indefinite duration, according to the IRS. So, a short-term disability doesn’t qualify for a tax waiver. The scarring of lung tissue in some COVID-19 patients might qualify, if it impairs lung function so severely that it prevents you from working.
The shorter time horizon for college savings is another reason to take a distribution from a retirement plan instead of a college savings plan. After the public health emergency is over, most families will have only 1-2 decades to save for college, compared to 2-4 decades to save for retirement.
Prepare for the Possibility of Job Loss
If you haven’t already built an emergency fund of half a year’s salary, start saving immediately.
If you already have an emergency fund, increase the size of the emergency fund.
In addition to covering unanticipated expenses, the goal of an emergency fund is to help to pay for necessary expenses during a period of unemployment.
Historically, the average time on unemployment was 3-5 months, so half a year’s salary was sufficient.
But, the Coronavirus outbreak may last for a year or more, so saving more money is smart.
If you lose your job, immediately make a list of your monthly bills. Call each company and ask what are they doing to help those impacted by coronavirus. Many places are willing to help.
