By Darrell Bryant
Your 401(k) is a wonderful resource that is helping you save for retirement. Maybe your employer is even contributing funds to make it grow even more. But then something crazy happens and you need cash—and you need it now. Are you tempted to tap into this retirement piggy bank early to take care of other expenses? If so, I urge you to read this first.
You may have heard that if you touch your 401(k) before age 59½, you’ll be hit with income taxes and a 10% early withdrawal fee. What you may not realize is how significant of a hit this is in the grand scheme of things—and you’re not alone. In fact, about 1 in 3 investors have taken withdrawals from their 401(k) before age 59½ (usually when changing employers), and it is taking a huge toll on their future retirement situation. (1)
It’s time for a reality check. If you’re considering cashing out your 401(k) early, consider the following, and take the time to search for alternative options.
The Immediate Consequences
Let’s look at a hypothetical example. Bob is 40 years old, runs into some financial trouble, and decides to cash out the $50,000 he has saved over the past 20 years.
Bob understands he’ll have to pay some penalties and taxes, but he doesn’t take the time to actually run the numbers. He makes the withdrawal, checks his bank statement, and is shocked at what he sees.
After paying 24% in federal income taxes, 6.5% in state income taxes, and a 10% early withdrawal penalty, Bob’s $50,000 has dwindled to $29,750—just over half of his original 401(k) savings.
And these are just the immediate consequences.
The Long-Term Consequences
Bob just erased all his momentum from 20 years of tax-deferred growth. He was at the point where his account was starting to snowball. He was earning interest off his interest. Now Bob has to start again from scratch; and at age 40, he has a lot less time to rebuild that snowball effect.
Realize that successful retirement investing is less about “how much did you save” & more about “when did you save it”. Assets accumulated early in life allow the magic of compound interest (see the rule of 72) to work in your favor.
Don’t Follow In Bob’s Footsteps
If you find yourself in a tough spot financially and are considering cashing out your 401(k) early, before you make a rash decision, I highly recommend speaking to a financial advisor. It may turn out that you have other, less financially devastating options available to you (such as taking a loan for your 401(k) or taking a hardship withdrawal), or a short-term loan or a HELOC from your local bank.
We at D. Bryant Retirement Strategies would love to explain your options and guide you on your financial journey. Whether you have questions about cashing out your 401(k) or you’re interested in creating a personalized financial plan to help reach your goals, reach out to us at (402) 932-2141 or email firstname.lastname@example.org to set up an appointment.
Darrell Bryant, CFS®, CAS® is Omaha’s Retirement Strategist. As the founder of D. Bryant Retirement Strategies, he focuses on helping individuals and couples nearing retirement do so successfully. Along with more than 30 years of experience, he received the Certified Fund Specialist (CFS®) designation and a Certified Annuity Specialist (CAS®) designation from the Institute of Business & Finance. Passionate about helping as many people as possible in his community, he hosts Retirement Strategies Radio, heard Saturday mornings at 8 a.m. on 1110 KFAB. He has also written articles on financial planning that have been featured on Fortune.com, FoxBusiness.com, Money.com, and in the Midland Business Journal. To learn more, visit his blog, his website, or connect with him on LinkedIn.