Here’s What Happens When You Take an Early IRA Withdrawal

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An early IRA withdrawal can be bad for your finances in several ways. Read on to learn about the consequences. 

It’s important to save for retirement so you end up with enough money to cover your living expenses without worry. And a good way to do that is to consistently put money into an IRA.

The upside of saving for retirement in an IRA over a 401(k) plan is that you’ll generally get more investment choices. Want to buy individual stocks like you do in your regular brokerage account? That’s usually an option, whereas with a 401(k), it often isn’t.

Meanwhile, one big perk of funding an IRA is getting a tax break on the money that goes into your account. But in exchange, the IRS requires that you keep your money in your IRA for a certain period of time.

And so if you take a withdrawal from your IRA prior to age 59 ½, you’ll generally face an early withdrawal penalty of 10%. This means that if you remove $10,000 from your IRA at age 35, you’ll lose $1,000 right off the bat (though it’s worth noting that there are exceptions, such as if you’re taking that withdrawal to purchase a home for the first time).

But taking an early IRA withdrawal doesn’t just mean facing a 10% penalty on the sum you’ve taken out of your account. It could also mean subjecting yourself to far greater losses than that.

When you miss out on the chance to grow your money

As just mentioned, IRAs allow you to invest your money in stocks. And it’s a good idea to do so, because over time, a stock portfolio might generate strong returns that allow you to grow plenty of wealth in time for retirement.

When you take an early IRA withdrawal, though, you don’t just lose out on the principal amount you’ve removed from your account. You also lose out in the form of forfeited investment gains.

Over the past 50 years, the stock market has delivered an average annual 10% return before inflation, as measured by the performance of the S&P 500 index. So let’s assume you remove $10,000 from your IRA at age 35, when your retirement age doesn’t arrive until 65. By not keeping that $10,000 invested at 10% for those 30 years, you’ll end up short around $175,000 in retirement income. And that’s a pretty big deal.

Steer clear of early withdrawals if you can

In some extreme situations, tapping your IRA early may be inevitable. Let’s say you need to repair your home immediately but you don’t have the money in a regular savings account and you’re unable to qualify for a loan. If there’s really no other way to get the money you need, then raiding your IRA may be your only option.

But generally speaking, try your best to avoid taking funds out of your IRA before retirement — even if you’re old enough to do so without incurring a penalty. Keeping your money invested for even a few extra years could do a lot for your nest egg, so if possible, avoid touching your IRA until your career has officially come to an end.

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