Cashing Out 401K Early to Pay Debt
As a young adult it can be very difficult to think about retirement. For most, the day where the office throws a farewell party and hands you a gold watch (or something of that sort) to say thank you for you years of service is one that will never arrive. Why should you even save for retirement? “Live in the now,” right? Wrong.
We all get in a bind with money at one point or another. We shuffle through bank accounts, credit card statements and more to try and find a little extra cash to get us by. A light eventually goes off as we think about that one account that is never touched, our 401K. A quiet account that keeps accumulating money just waiting for the day it can help bail us out of a financial crisis. Or some may think.
Tapping into your retirement fund is not something that comes without consequences. There may be a time when it is an absolute necessity to reach into the funds that are for your financial future. However, before you start the paperwork to receive your extra funds, you need to make sure you understand the penalties associated with taking money from your 401K early. Here is what you can expect.
Penalties for Cashing Out Your 401K
There is an immediate cost to cashing out your 401k. Your 401k plan administrator will withhold 20 percent to cover tax penalties and send it directly to the IRA. You won’t receive the full amount of the funds you have accumulated thus far. So will the amount you receive be worth it after the initial 20 percent is taken out?
For young retirement investors and those under the age of 59 ½, there will also be a withdrawal penalty. 10 percent will also be taken from the amount you are withdrawing as a penalty for emptying or withdrawing early from your retirement account.
If you are keeping track, that is 30 percent in penalties that is immediately taken. If you are withdrawing the amount of $20,000, you’re giving away $6,000. For some it can exceed 30 percent. That is a huge chunk of change.
Long-Term Effects in Withdrawing From Your 401K
Hard to Replace
Once you have cashed out those retirement funds, you will never see that money again. It can also be very difficult to replace. The money you have saved over time to help your financial future is no longer there. That is some serious long term consequences. You have set your retirement savings back significantly.
Loss of Tax Advantages
You do receive tax advantages when you contribute to your 401K. For one, you lower your taxable income. Another benefit, your earnings grow tax-free. If you don’t touch it, it continues to make money from you. Once you make a withdrawal you will owe income tax on those funds.
The Verdict on Whether You Should Cash Out Your 401K
Try to find another source for obtaining the amount you need. While it might seem like a good option now to pay off a credit card, buy a car or buy a house, the long term effects are not worth it. If you absolutely must cash out your 401K, Wells Fargo provides a helpful tool to help determine the risk. Make sure to have a long term plan on how you will help reboot your retirement savings and make sure your future is secure.
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