Investors pay dearly to tap retirement funds

By Allison Linn
|  Tuesday, Nov 18, 2008  |  Updated 12:27 PM EDT
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What You Need to Know Before Tapping Into Your 401K

Getty Images/Stock Illustration RF

According to the Internal Revenue Service, in most cases you must pay a 10 percent penalty if withdraw funds from your retirement account before reaching age 59½,.

 

After losing a job or suffering some other economic hardship, some Americans have decided they must withdraw money from their 401(k) or other retirement plan in order to cover expenses. Still, experts warn such a decision can carry substantial costs, and risks.

Here are answers to some frequently asked questions.

How much does it cost?
According to the Internal Revenue Service, in most cases you must pay a 10 percent penalty if withdraw funds from your retirement account before reaching age 59½, even if you decide to retire early.

In addition, you will likely have to pay regular income taxes on any money you withdraw.

Are there any exceptions?
Yes. For example, with an IRA, you may be able to avoid the fine if you are using the money to buy a home, you are unemployed and need to pay health care premiums or you are using the money for higher education.

If you have a 401(k), you may avoid the fee if you lost your job and are over age 55.

What are the other risks?
If you withdraw money early from your retirement account, financial experts warn that you face the double whammy of losing that investment in your retirement and losing out on the chance for that investment to grow. That could mean that you have to work longer or live with less in retirement.

 

What about borrowing against my retirement account?
The IRS allows people to borrow against their 401(k) plans but not their IRAs. Borrowing money against your retirement funds, rather than withdrawing the funds outright, can be a better option for getting cash now and still saving for retirement. You will still likely pay interest on the loan, however.

If you default on the loan, the IRS will consider that as an early withdrawal, which means you may be subject to penalties.

The IRS provides more information on early withdrawals here and here.

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