The financial news seems to be all gloom and doom these days. The reports are that we’re not in a recession, but times are tough for a lot of people.
No matter how tight things get, we still have bills to pay. People are responding to this very intelligently. They’re turning to public transportation, eating out less, seeking cheaper forms of entertainment, and cutting back on unneeded items.
But what do you do if that isn’t enough?
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Tapping your retirement plan …
It’s tempting to pull money out of your retirement plan, like a 401(k), especially if you change jobs. In fact, about 40 percent of job changers in their twenties and thirties have done just that, according to a recent report by the Financial Industry Regulatory Authority (FINRA).
… could cost you $130,000 …
If you’re under 59½, it’s usually not a good idea to cash out your retirement plan. Let’s look at the example that FINRA used:
You’re 30-years old with $20,000 in your 401(k). If you earn just 6% on that money until you retire at 62, you’ll have nearly $130,000 in your account, without making any additional contributions.
… and then some!
Of course, you can start over. But you lose the power of money compounding on top of money on top of more money, all accumulating tax free until you take it out. So it’s like taking at least two steps backward.
But that’s not all. Here are 4 other steps back:
- You’ll have to pay income taxes out of this money, since it was invested pre-tax.
- There’s also a 10 percent penalty for early withdrawal (unless you’re over 59½)
- Your employer is required to withhold 20 percent toward income taxes.
- If you owe money, your creditors can’t touch your 401(k) unless you cash it out.
By the time you get a check, that $20,000 will probably be more like $14,000 net of everything. So cashing out of your retirement plan is a short-term solution with long-term consequences.
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(Image by nighthawk7)
As far as these steps back go:
The income tax and the income tax withholding are kind of the same thing. The 20% income tax withholding will count toward the income tax that you would owe next spring.
BUT, there’s another step back: If your 401k $ is in the stock market, then it’s probably a really bad time to sell. The major indices (Dow, S&P 500, etc.) are in the ballpark of 20% below their highs just last year. The idea is to buy low and sell high, not the other way around.
If there’s any way you can borrow, then you’re probably better off. Even if you can’t borrow, the comment above that your creditors can only get your 401k money if you do cash out is crucial.
Ken, we can always count on you to bring more to our discussion. Thanks a bunch!
How do I cash out my retirement plan (from a company I worked for for 17+ years, and I am over 58 years old) instead of receiving a monthly payment? I was terminated from that job in 1999, but only learned that I had money coming from that company 6 weeks ago. I am currently working at another company.
Do you have any advice on this. I would like to discuss this with someone ASAP. Perhaps you might have some suggestions.
Thank you.