Wednesday, 1 December 2021

Hands off that IRA! Why Early Retirement Withdrawal is a Bad Idea

Hands off that IRA! Why Early Retirement Withdrawal is a Bad Idea
15 Feb
Building your retirement savings throughout a lifetime takes a lot of hard work and dedication. And if you’re going through a hard time, taking money out from your retirement savings can be tempting. But early retirement withdrawal has a lot of drawbacks that could hurt you in the long run.

4 Reasons not to take an early retirement withdrawal

1. 10% Penalty

If you have a Roth IRA, you can withdraw your contributions (but not your earnings) at any time without a penalty. For other IRAs, the minimum age for withdrawals without penalties is 59 and a half years of age. If you take money out of your retirement account before you hit this magic age, you’re subject to a 10% tax penalty. The penalty can potentially be waived if you qualify for an exemption (more about that below), but you might also have to pay income tax on those distributions.

This penalty can really cut into any earnings you’ve built up so it’s best to wait until you can withdraw the money penalty-free if at all possible.

Difficult to make up

One of the easiest ways to convince yourself to withdraw early is to tell yourself you’ll make up the payments when you have the money. But what if you don’t ever have the money again?

Depending on how much you withdraw, it can be difficult to get back to your earlier amount. Contribution limits could stop you from hitting the amount you had before the early withdrawal. You can contribute up to $6,000 to an IRA (or $7,000 if you’re 50 years of age and up) or $19,000 for your 401(k). If you take out a large sum of money, you might have a hard time adding that back in plus your regular contributions.

3. Loss of compound interest

Investments grow not only on the money you put in but the interest that grows from it. The more money you have in your account, the more interest you earn. And that money continues to build off itself, called compound interest.

Withdrawing money early takes away your chance to earn higher compounding interest.

4. You’ll regret it later

Taking away money from your future self to help your current self (or someone else) can seem tempting. But remember the purpose of retirement money is to have cash when you aren’t working or about to earn an income.

While you don’t know what your future holds as far as your finances, you might regret taking money away from your retired self. If you have to stop working before you’re ready to or a job loss forces you into retirement before you expected, you’ll need all the money you can get to make it through.

3 times you can make an early withdrawal without penalty

1. Educational expenses

If your grown child is having trouble affording college, you can use your retirement savings as a last resort.

Some retirement plans allow for higher education expenses as an early withdrawal exception. While your 401(k) plan might not, most IRAs will. Even though you might get taxed on the withdrawal, you won’t suffer through the 10% tax penalty for early withdrawal.

2. Home buying

Buying a home is one of the most expensive things you will go through. Affording a down payment, closing costs and a monthly mortgage payment can get pricey. But if you have an IRA and you’re a first-time homebuyer, you might qualify for up to $10,000 without getting hit with the 10% tax penalty.

3. Major emergency or hardship

Whether it’s a job loss, personal loss or another major financial burden, you could lean on your retirement savings for help.

It’s unfortunate to take money away from your older self, but if you don’t have emergency savings to cover unexpected costs, it might be your only option. If you have a low credit score that disqualifies you from getting a loan, an early retirement withdrawal is available.

If you have disability or another medical emergency, you can withdraw money from your retirement without facing a penalty. If you don’t have a qualifying health emergency but still need the money, you can make an early withdrawal but will face the 10% tax penalty on that cash.

Bottom line

Struggling to afford anything from major expenses to necessities might give you reason to take money out of your retirement plan. But if there is any other way to pay for those things before going through with an early withdraw, check them out. Do your best to avoid stealing money from your retired self. You have no idea what your future holds for you.

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Dori Zinn
Dori Zinn |

Dori Zinn is a writer at MagnifyMoney. You can email Dori here


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