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Amid pandemic, Americans making a $320 million retirement mistake

The Motley Fool logo The Motley Fool 6/30/2020 Katie Brockman
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The coronavirus pandemic has been incredibly costly for millions of people across the country. More than 45 million Americans have filed for unemployment benefits since the start of the pandemic, and although some states have started slowly reopening businesses, many people are still struggling to make ends meet.

The CARES Act aimed to help those who are facing financial hardship due to COVID-19, and it includes a provision that allows Americans to withdraw up to $100,000 from their retirement accounts without facing an early withdrawal penalty.

While some people may have no choice but to tap their retirement savings to get through tough financial times, there's one mistake that could be incredibly costly.

Withdrawing too much could cost you later 

Among those who withdrew money from their retirement funds to help pay for coronavirus-related expenses, the average withdrawal was around $5,500 in the month of April, according to a report from Fidelity Investments and Yahoo Money.

However, there were 3,200 individuals who withdrew the maximum amount of $100,000, the report revealed. That amounts to $320 million in retirement account withdrawals, and there are a couple of reasons why withdrawing this much can wreak havoc on your finances.

First, although you're not subject to an early withdrawal penalty under the CARES Act, you do still need to pay income taxes on your 401(k) and traditional IRA withdrawals. You will have three years to pay those taxes, thanks to the CARES Act, but for a $100,000 withdrawal, that's still going to be a hefty tax bill. And if you're already stretched thin financially, a huge tax bill probably won't help your situation.

In addition, withdrawing a significant amount from your retirement savings can throw off your entire retirement plan. Your savings rely on compound interest to help them grow, so the longer you leave your money untouched in your retirement account, the faster they'll compound. Taking even a few thousand dollars from your savings can cost you later, but withdrawing $100,000 can decimate your retirement fund.

Related video: 5 Opportunities You Can Dip Into Your Retirement Savings (provided by GoBankingRates)

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How much should you be withdrawing?

Before you decide how much to withdraw from your retirement fund, first ask yourself whether the withdrawal is absolutely necessary in the first place.

Taking money from your retirement savings should be a last resort, especially if you're nearing retirement and don't have much time to recoup your losses. It's particularly risky to be withdrawing while the stock market is volatile because if the market crashes again and you withdraw when stock prices are lower, you could end up losing money on your investments.

But if you've exhausted all your other options and have decided dipping into your retirement savings is the best move, carefully consider how much you should withdraw. Start small and only take out the bare minimum you need to get by, and then if you need more, you can consider making another withdrawal. Keep in mind you'll need to pay income taxes on your withdrawals, so try to avoid taking more than you need. Even if you plan to simply reinvest the amount you don't spend, those income taxes will still take a bite out of your savings.

The COVID-19 pandemic has caused significant financial hardship for millions of Americans, and tapping your retirement savings can potentially help make this situation a little easier. However, it's crucial to have a strategy when making withdrawals to ensure you're not hurting your future retirement.

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