During challenging economic times, it can be tempting to forego contributions to your retirement account, or even to pull money out of an existing account to cover other expenses. Some plans allow you to withdraw money for specific reasons (i.e. to prevent eviction or foreclosure), but there can be some pretty tough financial consequences for tapping or ignoring your retirement plan.
The FINRA Investor Education Foundation offers the following reasons to keep your retirement savings intact (note these rules are regarding
Tax Liability—Unless you're over the age of 59 ½, you will not only have to pay income taxes on the amount you withdraw, but you will also be subject to a 10% tax penalty. In most cases, your employer will withhold 20% in federal taxes, so the amount you receive will be significantly lower than the amount you requested.
Opening Assets to Creditors—Under the Bankruptcy Abuse Protection and Consumer Protection Act of 2005, your creditors cannot touch your 401(k) balance or similar retirement savings account—even if, as a last resort, you file for bankruptcy protection. Balances in traditional and Roth IRAs are also protected up to a limit of $1 million. However, if you take money out of your retirement plan through a loan, hardship or regular withdrawal, your creditors can go after that sum.
Additional warning: watch out for products that allow you to withdraw your retirement funds and reinvest them elsewhere. FINRA warns that 72(t) withdrawals from an IRA and 401(k) debit cards can deplete your retirement savings and damage your retirement security.
Instead of taking money out of your retirement plan, look at other ways to save or borrow (tightening your belt on expenses, taking advantage of employer match programs to keep funding your IRA or 401(k), contributing pre-tax dollars to a retirement plan, etc.) You may also be able to borrow from your 401(k) without actually taking a withdrawal; this would reduce your tax burden and would likely come with a lower interest rate than a bank loan. Check with your plan administrator on whether or not this option is available.