4 Reasons Never to Take Money Out of Retirement Accounts Early

This post may contain affiliate links which may compensate us based on your interaction. Please read the disclosures for more information.

If you’re considering early withdrawal from your retirement accounts, you should rethink that decision. Find out more. 

If you’ve put money into a tax-advantaged retirement account, you need to leave it there until retirement. This is true whether the money is in your 401(k) or whether you opened an IRA with a brokerage firm.

While you may be tempted to withdraw money from your retirement accounts in certain circumstances — such as if you’re facing financial difficulties — you want to avoid early withdrawals if at all possible. Here are four reasons why.

1. You could incur a penalty

With very limited exceptions, if you take money out of a 401(k) or IRA early (before age 59 ½), you’re going to be hit with a 10% early withdrawal penalty. This is money you just lose to the IRS for simply not waiting until you’re at least 59 ½ years old.

In addition to the 10% penalty, you’ll be taxed on the distribution at your ordinary income tax rate. You could also owe both state and federal taxes. This significantly reduces the amount you get to take home. Say you withdraw $10,000, are in the 22% federal tax bracket, and pay 8% state taxes. You could lose around this much money to taxes:

$1,000 for an early withdrawal penalty$2,200 for federal taxes$800 for state taxes

You’d only end up with $6,000 in usable funds of the $10,000 you took out, with the rest going to the government.

2. You’ll miss out on compound growth

When you take money out of a retirement account early, it stops working for you. You lose out on all the compound growth you’d have benefitted from if you hadn’t withdrawn the funds early. That’s a huge loss, given the long timeline your money might otherwise have been invested for.

Say you took out that $10,000 around 30 years before retirement. If you’d left it alone and it had earned 10% average annual returns, it would have turned into $174,494.02. You will cost yourself a lot of money due to your early withdrawal.

3. Retirement accounts are protected

If you are really in financial trouble, you may still want to hold off on taking any money out of a retirement plan. Most tax-advantaged retirement accounts are protected in the event of a bankruptcy. That means even if you get your debt discharged, you’ll still be able to keep your retirement funds.

It would be a bad financial choice to withdraw money from these retirement plans, end up having to declare bankruptcy anyway because it didn’t fix your financial problems fully, and then lose retirement money you otherwise could have kept.

4. You need a big retirement account balance to have a comfortable retirement

Raiding your retirement accounts could have dire consequences in the future. Most seniors need to replace around 70% or more of their pre-retirement income, and Social Security replaces around 40%. Without a big retirement account nest egg that provides enough income to cover the rest of your costs beyond what Social Security can pay for, you could be in dire straits.

As a senior, it can be a lot harder to cope with a shortfall than when you’re young, working, and have options. So don’t steal from your future self by taking money from your retirement accounts early.

What can you do instead?

So, there are plenty of reasons not to take money out of retirement accounts early. But what can you do instead if you really need the money today? Here are a few options:

Look into affordable borrowing options: If you have a pressing need, could you use a 0% APR credit card or a personal loan to cover the costs and pay them off over time? Take advantage of government benefits: Programs like SNAP and Temporary Assistance for Needy Families can help you in hard times. Benefits.gov can help you identify assistance you may be eligible for. Talk to creditors: If you’re experiencing temporary hardship that’s preventing you from being able to pay bills temporarily, talk to your creditors about your options. They may be able to work out a payment plan or allow you to pause payments.Downsize: If you can’t cover your costs, consider moving to a cheaper location, selling your car and getting a cheaper used one, or otherwise scaling down your lifestyle. Better to do it now voluntarily than later when you’re forced into it as a senior. Take on a side hustle: The average side gig provides $483 per month in income. If you can pick up a temporary side job, you could potentially cover the costs you’re thinking of draining your retirement fund to pay for. Put off your purchase: If you don’t absolutely need to incur the costs right now, you shouldn’t be taking money out of your retirement plan to pay for them.

The bottom line is, you should not take money out of retirement plans if there are any other options, so explore these solutions first before even considering raiding your future funds.

Our best stock brokers

We pored over the data and user reviews to find the select rare picks that landed a spot on our list of the best stock brokers. Some of these best-in-class picks pack in valuable perks, including $0 stock and ETF commissions. Get started and review our best stock brokers.

We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Christy Bieber has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

 Read More