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When it comes to making a k early withdrawal, there are a number of reasons why it might be tempting. With millions still unemployed due to the pandemic, unexpected expenses are taking a particularly hard toll. However, is the benefit of withdrawing your retirement savings early truly worth the cost?
For many people, their k is their primary method of investing in their financial future. On the surface, withdrawing funds from your k might not seem like a bad option under extenuating circumstances, but you could face penalties. Young adults are especially prone to early withdrawals because they figure they have plenty of time to replace lost funds. Ultimately, you could lose a substantial portion of your retirement savings if you choose to withdraw your k early to use the money to make other risky financial moves.
In the best case scenario, you might receive some money back in the form of a tax refund if your withholding exceeds your actual tax liability. Compounding is the snowball effect resulting from your savings generating more earnings — not only on your principal investment but also on your accrued interest.
You might need to get creative with a passive income stream to help support you later in life. See how it works with our compounding interest calcultor. In certain cases, it actually might be strategic to move forward with k early withdrawal. For example, it could be smart to cash out some of your k to pay off a loan with a high-interest rate, like 18—20 percent. You might be better off using alternative methods to pay off debt such as acquiring a k loan rather than actually withdrawing the money.
Always weigh the cost of interest against tax penalties before making your decision. Some k plans do allow for penalty-free early withdrawals due to a layoff, major medical expenses, home-related costs, college tuition, and more. Regardless of your strategy to withdraw with the least penalties, your retirement savings are still taking a significant hit. Knowing the differences between a k early withdrawal, a hardship withdrawal, and a k loan is crucial. Due to the many obstacles to make a k early withdrawal, you may find you want to keep it untouched.
Most likely, you will save money and have a wider range of investment options when you transfer your funds. Also, be aware that the process is more complicated for indirect rollovers. In short, k early withdrawals are usually counterproductive. Prevent compromising your hard-earned savings by using a free budgeting tool that will set you up for success.
After all, being prepared and informed are two of the most important parts of maintaining financial health. Source: SEC. Mint is passionate about helping you to achieve financial goals through education and with powerful tools, personalized insights, and much more. Be sure to speak with your HR department to see whether your situation might provide penalty free hardship withdrawals.
Otherwise, hardship withdrawals carry the same risks as k early withdrawals. According to Stiger, the greatest of these issues is the hit to your compounding returns:. Of course, the loss of compounding is a long-term effect that you may not feel until you get closer to retirement.
A more immediate risk may be your current tax burden since your distribution will likely be considered part of your taxable income. If your distribution bumps you into a higher tax bracket , that means you will not only be paying more for the distribution itself, but taxes on your regular income will also be affected.
Consulting with your certified public accountant CPA or tax preparer can help you figure out how much to take without pushing you into a higher tax bracket. The easiest way to avoid these risks is to resist the temptation to take an early k withdrawal in the first place. If you absolutely must take an early distribution, make sure you withdraw no more than you absolutely need, and make a plan to replenish your account over time.
This can help you minimize the loss of your compound returns over time. Since penalty-free withdrawals are available for a number of financial hardships and situations, plan participants who take an early withdrawal with a penalty are often in serious financial straits. Taking an early withdrawal can make sense if you are able to take advantage of a penalty-free exception, use the Rule of 55 or the SEPP exemption. But might make sense to exhaust other options first—check out these 10 ways to get cash now.
Emily Guy Birken is a former educator, lifelong money nerd, and a Plutus Award-winning freelance writer who specializes in the scientific research behind irrational money behaviors. Her background in education allows her to make complex financial topics relatable and easily understood by the layperson. John Schmidt is the Assistant Assigning Editor for investing and retirement.
Before joining Forbes Advisor, John was a senior writer at Acorns and editor at market research group Corporate Insight. Select Region. United States. United Kingdom. Emily Guy Birken, John Schmidt. Contributor, Editor. Editorial Note: We earn a commission from partner links on Forbes Advisor. Commissions do not affect our editors' opinions or evaluations. What Is a k Early Withdrawal?
Withdrawals are taxed. Even if it were covered by an exception, all early withdrawals from your k are taxed as ordinary income. Less money for retirement. Perhaps the biggest consequence of an early k withdrawal is missing out on long-term returns in the market. Take Out a k Loan A k loan lets you borrow money from your own retirement savings without incurring taxes or penalties, provided you pay the loan back within five years. Was this article helpful?
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The Bottom Line The sooner you begin saving for retirement, the better. When you start early, you can afford to put away less money per month since compound. But first, a quick review of the rules. The IRS dictates you can withdraw funds from your (k) account without penalty only after you reach age 59½, become. Cashing out a (k) or making a (k) early withdrawal can mean paying the IRS a 10% penalty when you file your tax return.