Why You Shouldn’t Use Your 401(k) Savings Early

Why You Shouldn’t Use Your 401(k) Savings Early

According to a recent Bloomberg article, the Internal Revenue Service collected $5.7 billion in 2011 from early retirement savings withdrawal penalties, meaning Americans took about $57 billion before they were supposed to. And according to a Gallup survey released May 2, 48 percent of non-retired Americans plan to rely on retirement accounts as a major source of income.

While you are employed by a company that offers a 401(k), you usually have an opportunity to access savings under certain hardship conditions. The drawback, however, is that qualifying for this provision can be difficult. Just as the IRS has its list of qualifying financial hardships (medical expenses or disability), individual plans often do as well. That means you must qualify under both sets of rules, which may be more difficult. And just because you meet certain qualifications doesn’t mean you should start siphoning your retirement fund just because it is there.

A withdrawal from your 401(k) may seem like a great option and an untapped resource for large expenses, like a down payment on a house, but there are consequences to consider. When you withdraw 401(k) funds, you will pay income taxes on the money withdrawn and face an early withdrawal penalty, usually 10 percent if you are younger than 59 ½ years. Additionally, future tax-deferred earnings and compounding on the savings are lost.

Also, depending on the rules of an employer’s 401(k) plan, you may be able to borrow from their retirement accounts and pay the loan back with interest, without incurring the tax penalty. Most loans must be repaid within five years and there is added risk with these loans as many 401(k) plans require employees to immediately repay loans in full when leaving a job.

While this may allow you the funding you need for something now, this dent to your retirement finances could be enormous based on your age at the time of withdrawal and how much you have saved in total. With these consequences in mind, you should carefully evaluate before withdrawing from your 401(k) unless you are under extreme hardship conditions and you have no other options.

If you or someone you know is considering borrowing from a retirement nest egg early, call a financial advisor for a consultation and learn more about potential penalties and what other options might be available.

FINANCIAL FACTS

More and More — Health care spending by the federal government represented 2.1 percent of federal spending in 1962, but had risen to 27.7 percent of spending by 2013 (source: Brookings Institution, BTN research).

Through the End of April — The S&P 500 was up 2.6 percent YTD (total return) through April 30, 2014, 10.1 percent less than the YTD return of the stock index as of April 30, 2013 (when the S&P 500 was up 12.7 percent). The total return for the stock index for all of 2013 was a gain of 32.4 percent. The S&P 500 consists of 500 stocks chosen for market size, liquidity and industry group representation. It is a market value weighted index with each stock's weight in the index proportionate to its market value (source: BTN Research).

Many Less — As of March 31, 2014, there were 1.99 million existing homes for sale in the U.S. Just five years earlier on March 31, 2009, the number of homes on the market was 3.65 million (source: National Association of Realtors, BTN Research).