It’s a decision that could cost you a lot of time.
- When you need money in a pinch, you may be inclined to tap into your IRA or 401(k).
- This could lead to a world of undesirable consequences.
- You don’t want to face a tax penalty or be left without enough money to live on in retirement.
Putting money into an IRA or 401(k) plan for retirement is undoubtedly a good idea. Once you stop working and earning a paycheck, expect to need more than just Social Security to make ends meet. And if you don’t have a pension or other obvious source of income for retirement (many workers today don’t), you need savings to supplement those benefits.
If you have money in an IRA or 401(k) in the meantime, you can rest assured that you won’t have to worry as much about building an emergency fund. After all, when you have thousands of dollars in a retirement plan, you can always withdraw in case an immediate cash need arises, right?
Not correct. While you might get away with a premature crackdown on your IRA or 401(k), it could lead to a world of unfavorable consequences, points out financial expert Suze Orman. So leave your retirement savings alone and build a savings account instead.
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Early retirement is bad news
The problem with tapping an IRA or 401(k) before retirement is two-fold. First, if you withdraw from any of these plans before the age of 59 ½, you will face a 10% penalty if you withdraw those funds early. So if you withdraw $10,000 at the age of 40 to cover some medical bills, you lose $1,000 immediately. If you have a traditional IRA or 401(k), you’ll also pay taxes on your withdrawal (although, to be fair, you’d pay them in retirement too).
Why such a high penalty? The IRS offers tax breaks to workers who contribute to an IRA or 401(k). Specifically, the money you invest in a traditional IRA or 401(k) goes in tax-free, so if you put in $3,000 in a year, that’s $3,000 in income that the IRS won’t tax you becomes.
But the IRS wants IRA and 401(k) participants to reserve that money for retirement. And so it doesn’t take early withdrawals well – clearly.
Expensive penalties aren’t the only reason to avoid an early IRA or 401(k) withdrawal. The other problem is that the more money you withdraw from one of these accounts earlier in life, the less money you will have later in life. And that means you’re risking a financial squeeze at a time when working part-time might not be an option due to health or mobility issues.
Leave your retirement savings alone
If you’ve managed to amass a nice nest egg for retirement, congratulate yourself. But that doesn’t mean you’re off the hook when it comes to building an emergency fund.
You need money in a regular savings account to cover things like sudden home repairs, car-related problems, and medical bills — or to cover your expenses in the event of an unexpected layoff. And the sooner you put this short-term safety net in place, the more confident you can be about your finances as a whole.