Tapping Into Your Retirement Savings Early? Here’s What To Consider
Withdrawing retirement savings early is possible with most accounts, but there are significant downsides. Here’s what you need to know.
February 15, 2022
Retirement savings stashed away in 401(k), IRA or pension accounts are designed to be used for funding your lifestyle during retirement. Generally, they cannot be withdrawn without penalty until you reach the age of 59½.
What happens if you have a financial emergency and you need to tap into your retirement savings early?
And what happens if you retire early and you need to support your lifestyle before the “standard” retirement age?
With most retirement accounts, it’s possible to withdraw funds at any time. However, there are some tax implications to be considered, and there may be early withdrawal penalties.
Here’s everything you need to know about how to withdraw from 401(k) and other retirement accounts — and what fees and taxes you may need to pay.
Early retirement withdrawals
Before you withdraw funds from a retirement account, it’s important to be fully aware of the consequences. Here are some important considerations.
There may be tax penalties
The IRS provides generous tax benefits on retirement accounts, but the catch is that the money cannot be withdrawn before retirement age.
If money is withdrawn early, there may be tax consequences such as a pension early withdrawal penalty. In many cases, this consists of a 10% tax penalty.
For example, if you withdraw $10,000 early, you may have to pay $1,000 as a penalty to the IRS. There are a few exceptions to this rule, but most early withdrawals will be subject to the 10% penalty.
You’ll also have to pay income tax on the profits you’ve made. As a result, you may need to withdraw far more than you anticipated in order to cover your expenses.
Roth IRA early withdrawals are treated differently
With a Roth IRA or Roth 401(k), you have more flexibility in how you can withdraw money.
This is because Roth contributions are made post-tax, meaning that you’ve already paid taxes on the contributions you’ve made to a Roth account.
Because of this, you can generally withdraw money from Roth retirement accounts without paying taxes or penalties. It’s important to note that you can only withdraw the principal, meaning the amount you put in. If you withdraw any profits or interest you’ve earned, you will then need to pay taxes and may face penalties.
There are some cases where you can withdraw Roth earnings penalty-free — for example, if the money is used for a qualifying expense, like a house down payment, college tuition, etc. The rules are complex, though. Check out this explainer for details and consult with your tax advisor for personalized advice.
You won’t be able to redeposit the withdrawn funds
Once you withdraw funds from a retirement account, you cannot simply “put them back” at a later date. You can continue making your yearly contributions, but if you withdraw $100,000 you cannot simply redeposit another $100,000 down the line.
It can throw your retirement plans off track
The earlier you can invest, the more your money has time to grow. By withdrawing early, you will be forfeiting substantial future earnings potential.
To illustrate, let’s say that you withdraw $10,000 from your Roth IRA at age 30. If you had left that money invested, it could have grown into $106,766 by the time you retire at 65, based on 7% average stock market returns.
You may qualify for a “hardship distribution”
If you are facing a substantial financial hardship, such as a disability, a serious illness or the loss of a loved one, you qualify for what is known as a hardship distribution.
This is essentially an early 401(k) withdrawal that can be made without the tax penalties that usually come with these withdrawals. For help with figuring out how to withdraw from 401(k) using a hardship distribution, it’s best to consult a tax professional.
How to withdraw money from retirement accounts
The process for early withdrawals from a retirement account will vary depending on the broker and the type of account.
In many cases, you can simply sell assets and withdraw the funds to your bank account — it’s the tax reporting bit that can be tricky.
Because of the complexity of these tax penalties and the income tax on early withdrawals, it’s a good idea to consult a tax professional before withdrawing retirement funds early.
How to withdraw from 401(k) accounts
Generally, the process for how to take money out of 401(k) accounts is the same as any other retirement account. You can sell assets, request a withdrawal and transfer the money to your bank account.
You will then need to report the withdrawal to the IRS and pay any necessary fees and taxes.
Alternatives to withdrawing your retirement funds
In most situations, withdrawing early from your retirement funds should be a last resort. Here are some alternatives to consider that have fewer downsides.
Liquidating other assets
If you have other assets that you can sell, this could be a good option before touching your retirement stash. You could sell:
Investments in a normal taxable brokerage account
An extra vehicle or RV
Expensive artwork or furniture
Coins, precious metals, jewelry or collectibles
Loans from your retirement accounts
With certain retirement accounts, like a 401(k), you can actually borrow money directly from your account. You essentially loan the money to yourself.
You’re required to pay interest, but the interest you pay goes into your retirement account when you pay it back.
This strategy does not result in 401(k) early withdrawal fees or penalties, so it could be a great alternative if it’s offered by your broker or 401(k) provider.
Margin loans against your retirement accounts
Some brokers allow you to take out a margin loan that uses your retirement savings as collateral.
For instance, if you have $400,000 in your retirement account, your broker may allow you to borrow up to $100,000 in cash. Your retirement funds would stay invested, and you would simply pay interest on the loan you receive.
Unlike taking a loan from your own account, the interest you pay goes to the broker. The upside is that your assets can stay invested inside your account.
This strategy does have risks. If the stock market crashes, your assets may be sold automatically by the broker in order to cover the loan in what is known as a margin call.
Other types of loans
Finally, other types of loans may help bridge the gap to cover your financial needs. In some cases, these can make more sense than selling retirement savings. This could include:
A home equity line of credit (HELOC)
Keep in mind that these loans — particularly revolving loans like credit cards — can lead you down a slippery slope of debt.
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