Retirement plans, such as 401(k)s, IRAs and many others, provide advantages to an investment account. Therefore, the money in these funds should be treated as “sacred.” If you take money out of these funds before age 59.5 years of age, not only will you miss out on the advantages of such an account but you’ll incur a penalty. In other words you won’t benefit from the retirement savings efforts you’ve made up to this point. Each account has specific rules so be sure to understand your accounts thoroughly before making any decisions.
If you withdraw funds early you’ll pay a 10% penalty as well as ordinary income tax. Ten percent might not sound that bad but according to the May 25, 2014 issue of Bloomberg Businessweek, “A 30-year-old who cashes out $16,000 could lose $471 a month in retirement-income cash flow by not leaving it invested in a retirement account, assuming retirement age 67 and death at age 93, according to Fidelity analysis that assumes a 4.7% annual return and a 401(k) balance at retirement of $87,500.” Over the course of retirement that totals $146,952 which is not a sum of money we want to miss out on!
Can’t Get Money Back In
There is a limit to the amount you can contribute each year. Therefore, if you withdraw funds early, you probably can’t get that money back in the account. For 401(k)s in 2014 the limit is $17,500 and for IRAs it is much less at $5,500. If you make a withdrawal its nearly impossible to recreate years of contributions. In some instances you can put money back in, but those are very limited. You also lose out on the tax deferred growth that withdrawn funds would have been earning.
Alternatives to Early Withdrawal
Consider alternatives to early withdrawal. Some 401(k) plans offer a loan option, the terms of the loan could be more favorable than the penalty and tax associated with an early withdrawal. Depending on your circumstances, even consumer debt, which is not generally favourable, could be the “lesser of the evils.” Ideally, you have an emergency fund in place so that you can avoid tapping into retirement plans.
There are other items to consider, here are a few of them. In certain types of accounts there are exceptions to the early withdrawal penalty for specific reasons such as disability and medical needs. Also, retirement plans are often left in tact during bankruptcy. Keep your retirement account sacred and continue to SaveUp!
This post was written by SaveUp’s personal finance contributing writer, Catherine Hawley, CFP®.