The True Cost Of Withdrawing Early From Your 401(k)
By Preston Rosamond
After the challenging year we’ve all just endured, I’m sure the desire to enjoy a satisfying retirement free from worry has never been higher. Although the ideal retirement might look different from person to person, one universal goal is to not outlive our funds after the steady paychecks stop coming in. Achieving this goal is no easy task, but there’s nothing more resourceful than a 401(k) to help you out. And if your employer is contributing funds to grow this nest egg even more, all the better!
By now we’re all painfully aware of how unpredictable life can be, so what if something crazy happens and you need cash—and you need it now? If you’re tempted to crack open your retirement piggy bank early to help out with some pressing expenses, we 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 are thinking about cashing out your 401(k) early, consider the following, think twice, and take the time to search for alternatives.
The Immediate Consequences Of Cashing Out Your 401(k) Early
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 those are just the immediate consequences.
The Long-Term Consequences Of Early Withdrawals
Bob also just erased all his momentum from 20 years of tax-free growth. He was at the point where his account was starting to snowball. He was earning interest off his interest. Now he has to start again from scratch; and at age 40, he has a lot less time to rebuild that snowball effect.
Even worse, after realizing he made a huge mistake, Bob did some investigating and realized he had other options available to him. It turns out that the withdrawal (and all the consequences) wasn’t necessary after all.
It was a costly mistake that could have been avoided.
Don’t Make Bob’s Mistake
Withdrawing from your 401(k) early is a major decision. With any big decision, especially when escalated emotions make it more difficult to make rational decisions, it’s wise to seek professional advice. If you ever find yourself in a tough spot financially and are considering cashing out your 401(k), a financial advisor can help you navigate your other, less financially devastating options (such as taking a loan for your 401(k) or taking a hardship withdrawal).
We at The Rosamond Financial Group are here to listen to your story and help you explore your options. If you have questions about cashing out your 401(k) or you’re interested in creating a personalized financial plan to help reach your goals, we invite you to schedule an introductory meeting to see if we are the right fit for you. Call my office at 830-798-9400 or email firstname.lastname@example.org. We look forward to hearing from you soon!
Preston Rosamond is a financial advisor and the founder of The Rosamond Financial Group Wealth Management, LLC with nearly two decades of industry experience. He provides comprehensive wealth management and financial services to individuals, professionals, and families who enjoy simplicity and seek a professional to help them pursue their goals. Preston personally serves his clients with an individual touch and a sincere heart, and his servant’s attitude is evident from the moment you meet him. Learn more about Preston or start the conversation about your finances with him by emailing email@example.com or schedule a call with our online calendar.