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Retirement account funds should be saved for retirement, but sometimes life has other plans. Read on to see what to expect if you tap your 401(k) early.
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The best retirement accounts are the kind where it’s easy to put money in, but a lot more difficult to take money out. If you have access to a workplace 401(k) account, you make contributions with no effort at all — your company’s human resources department likely set it up for you, and you elected to have a certain amount of your pre-tax income from every paycheck sent to it. Easy peasy.
But you also have the option to take money out of a 401(k), and depending on the circumstances, it could cost you quite a bit. And in any case, leaving yourself with less money for retirement will have a definite impact on your future. Let’s take a look at the consequences of making an early 401(k) withdrawal.
You’ll pay taxes
Remember, you contribute to a traditional 401(k) with pre-tax dollars, and pay taxes on the money when you take withdrawals in retirement. Well, pulling money out early means paying taxes on it early, too. So get ready to pay your regular income tax rate on the money you take out. And depending on your tax bracket, that could be quite a chunk of change to pay. The reason many people like traditional 401(k)s and IRAs (as opposed to those of the Roth variety) is that if you expect your tax bracket to be lower in retirement, it’ll save you money.
You’ll pay an additional penalty
In addition, if you’re under age 59 1/2, the IRS will likely assess a 10% penalty on the amount you withdraw from your 401(k). This means that if you take out $15,000, you’ll lose $1,500 of it to this penalty. There are a few exceptions, though. If you’re 55 or older and are leaving your job, you won’t be charged for taking money out of the 401(k) you have through that job. If you suffer a permanent disability, have a large amount of medical expenses, or are impacted by a natural disaster, you may also be exempt from the 10% penalty due to hardship.
You’ll miss out on future growth
This last consequence of an early 401(k) withdrawal is one for your future self. Ideally, that money is for your retirement years, and by saving and investing it now, you’re giving it the chance to grow to a larger sum. If you take money out, that cash won’t grow, and you could end up short on funds in retirement. So be sure to consider the big picture before making an early withdrawal.
What about a 401(k) loan?
Making an early 401(k) withdrawal should be a last resort due to the costs involved and of course, that lost growth potential and the chance of leaving yourself short on money in retirement. But if you have no other options (such as an emergency fund), you might consider a 401(k) loan instead. A loan will still see you missing out on growth on the money you take out, but if you pay it back within five years (with interest), you won’t owe taxes or a penalty. A 401(k) loan could also be fraught with complications, as if you leave your job during the repayment period, you still have to repay the loan, or default on it and owe aforementioned taxes and a penalty.
Whether you take an early withdrawal or a 401(k) loan, it’s not ideal to break into that money before retirement, due to the consequences involved.
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