Why You Shouldn’t Withdraw Early From an IRA or 401(k)
When you’re faced with serious money sucks—say, unemployment, a new home or the prospect of funding your child’s college education—it can be tempting to dip into your retirement nest egg. If you’re still some years away from retirement, you may think, I have plenty of time to replace this cash … and it’s just sitting there.
But before you start treating your retirement savings like a rainy day fund, think about whether the short-term payoff is really worth the cost.
Withdrawing early from that tantalizing nest egg can lead to a bevy of unexpected taxes. The government has stiff penalties for early withdrawals from most retirement plans in order to ensure that your retirement funds are used for intended purposes.
So be sure to brush up on the rules for IRAs, Roth IRAs, 401(k)s and 403(b)s if you’re thinking about cashing out before that egg has hatched. In the meantime, here’s the gist of what you’ll face if you do choose to withdraw early:
Penalties for Early Withdrawals
Across the board, these four retirement plans follow the same general guideline: Withdrawals from IRAs, Roth IRAs, 401(k)s and 403(b)s are considered “early distributions” before you reach 59 and a half years old. There are exceptions to this rule, but assuming that you aren’t disabled or saddled with large medical expenses, early withdrawals are hit with a 10% penalty by the federal government, and possibly another 10% withdrawal tax depending on the state and the applicable income taxes on the distribution itself.
RELATED: 7 Reasons You Need an Emergency Fund
“Those who withdraw early may end up losing 40-50% of their money between taxes and penalties,” says Stephany Kirkpatrick, director of financial planning at LearnVest Planning Services. If you want to avoid this loss, and you foresee such shorter-term expenses as a home purchase or a potential job loss, she recommends putting money into a savings account or a CD, rather than investing it. “Then there aren’t market risks, taxes or penalties,” Kirkpatrick says.
Exceptions for Early Withdrawal Penalties
You may be able to dodge the early withdrawal penalty—even if you’re not yet 59 and a half—if you meet certain exceptions. In all of these cases, the distributions will still be taxed as income, unless you have a Roth IRA, which is already comprised of post-tax contributions.