During challenging economic times, it can be tempting to forego contributions to your retirement account, or even pull money out of an existing account to cover other expenses. “Some plans allow you to withdraw money for certain hardship reasons (to prevent eviction or foreclosure, for instance), but there can be some pretty tough financial consequences for tapping or ignoring your retirement plan,” warns Claire Rosenzweig, President and CEO of the BBB of Metro New York.
The BBB and the Financial Industry Regulatory Authority (FINRA) work together to promote investor education and fraud prevention. The FINRA Investor Education Foundation offers the following good reasons to keep your retirement savings intact (note these rules are regarding U.S. laws):
Tax Liability—Unless you're over the age of 59 ½, you will not only have to pay income taxes on the amount you withdraw, you will be subject to a 10% tax penalty. In most cases, your employer will withhold 20% in federal taxes, so the amount you receive will be significantly lower than the amount you requested.
Opportunity Costs—The repercussions of withdrawing funds from your 401(k) could be enormous in terms of lost growth opportunity. For example, a 30 year old with a 401(k) balance of $20,000 can retire with $129,068 at age 62 (at an average annual rate of return of 6%), even if they do not make any additional contributions during that time. Even if you have a shorter time horizon, you will forgo significant savings opportunities by taking money out of your 401(k). For a 45-year-old, that $20,000 can grow to $53,855 in 17 years.
Opening Assets to Creditors—Under the Bankruptcy Abuse Protection and Consumer Protection Act of 2005, your creditors cannot touch your 401(k) balance or similar retirement savings account, even if you file for bankruptcy protection. Balances in traditional and Roth IRAs are also protected up to a limit of $1 million. But if you take money out of your retirement plan through a loan or a withdrawal, your creditors can go after that sum.
You may be able to borrow from your 401(k) rather than taking a withdrawal. Some employers allow 401(k) loans only in cases of financial hardship, but others allow you to borrow for other purposes. As opposed to a withdrawal, you won't pay taxes and penalties on the amount you borrow, as long as the loan is repaid on time. Interest rates on 401(k) plan loans are consistent with traditional bank loans. The difference is that the interest you pay is generally credited to your own plan account; you pay interest to yourself, not to a bank or other lender.
To find out if you're allowed to borrow from your 401(k) plan and under what circumstances, check with your plan's administrator or read your summary plan description.
For more information on this and other financial topics, check out www.saveandinvest.org. Visit www.newyork.bbb.org for more tips and advice you can trust.
