401k Early Withdrawal

Are you thinking of making an 401k early withdrawal? In this dismal economic climate, it’s hard to ignore the seemingly large sum of money sitting untouched in your account. No one can make this decision on your behalf. It’s your money and your choice, but there are a few issues you should consider before making a final decision. How will your early withdrawal affect your financial future? What kind of penalties will you have to pay? Are there any options?

The first thing to consider when contemplating a 401k early withdrawal is how it will affect your retirement and your savings portfolio. One of the biggest benefits of a 401k is that both the principal and the earnings remain in the account without taxes, building interest at an ever increasing, exponential rate. Removing money from the account stops this beneficial cycle. The few thousand dollars you remove today can cost you hundreds of thousands in retirement income. From this perspective, taking money from your 401k retirement account should be a last resort.

Another issue that should be addressed is penalties. Just as the IRS offers incentives and tax breaks to encourage investors to invest in a retirement account, they discourage early withdrawal from 401k with hefty penalties. Taking money out of a 401k retirement account before you turn 59 and one half years of age usually will force you to pay ten percent of your money in early withdrawal and ten percent in taxes. That makes a total of one fifth of both your principal and your earnings. You will also have to pay income tax on any earnings your account made while it was tax deferred. Altogether, you will be paying one prohibitively large tax bill.

You can avoid paying the penalties for early withdrawal if you are having one of a set list of financial hardships, which include high medical bills, disability, college tuition, or buying your first home. However, most people still would benefit more from keeping the money in this high earning account if at all possible.

Taking money from your 401k probably doesn’t seem like such a good idea anymore, but are there any options? The first option is taking a loan from your retirement account. Most plans allow this as an alternative to a 401k early withdrawal. You would have to pay interest, just as you would with a traditional loan, but unlike a traditional loan the interest would be paid into your 401k where it would earn compound interest and enhance your retirement.