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 certain hardship reasons (to prevent eviction or foreclosure, for instance), but there can be some pretty tough financial consequences for tapping or ignoring your retirement plan.
The FINRA Investor Education Foundation offers the following good reasons to keep your retirement savings intact (note these rules are regarding U.S. laws):
- 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.
- Opportunity Costs —The repercussions of withdrawing funds from your 401(k) could be enormous in terms of lost growth opportunity. For example, let's assume you are 30 years old, and have a 401(k) balance of $20,000. If you leave that money alone, and your account averages a 6% rate of return over the next 32 years, your balance at retirement will be $129,068 when you're 62—even if you do not make any additional contributions during that time. If you take it out, you'll have nothing. Even if you have a shorter time horizon, you will forgo significant savings opportunities by taking money out of your 401(k). For a 45-year-old, that $20,000 will grow to $53,855 in 17 years.
- 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. But if you take money out of your retirement plan through a loan or a hardship or regular withdrawal, your creditors can go after that sum.
Another 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.
It’s best to 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.
For more information on this and other financial topics, check out www.saveandinvest.org.