Can You Take Money Out of Your Retirement Account Early(401k, IRA, Roth IRA)?
Saving for retirement is incredibly important, we all know that. Sadly, many people are not saving enough for retirement. Sometimes life happens and you find yourself strapped for cash when you need to pay for a large bill. You look at your accounts and realize you have a pretty good chunk of money sitting in your IRA, should you use that to pay for your bill? The short answer is that taking money out of your IRA before retirement should be a last resort. Lets talk about why.
Even if you don’t envision a retirement that mirrors the baby boomers right now, you should still be saving and investing for the future. And a retirement account is a great way to do that since they have tax benefits. Taking money out of these accounts early is detrimental for 3 reasons.
1. You will pay tax and an IRS penalty on your distributions
2. There is a limit to how much you can put in each year so you cant really go back an put a lot more in down the road to try and make up for it
3. You interrupt the compounding interest.
Lets take a deeper dive into each of these three components.
1. If you take money out of your pre-tax 401k or IRA before you turn 59.5 then you will have to pay a 10% penalty plus income tax on the amount of the distribution. That is a hefty amount of money that will really set you back financially. If the account is a Roth account then you will pay a 10% penalty on distributions as well, but not taxes. The exception to the 10% penalty is that you can take out your contributions without paying a penalty as long as you have had the Roth IRA open for more than 5 years. There are some other exceptions that may allow you to avoid the 10% penalty. You can find more about that on the IRS website: https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-exceptions-to-tax-on-early-distributions
2. In 2024 you can put $23,000 into your 401k and $7,000 into your IRA each year. So, say you get yourself back on track financially after taking out your early withdrawal, you are limited to those contribution amounts each year. Even if you start making serious money or come into some sort of windfall, you cannot go back and put the money back in that you took out years earlier.
3. Interrupting compound interest. What is compound interest? That is when you start to earn a return, or interest not just on the money you contributed but on interest and growth from previous years too.
Lets look at an example of this. Say you have $50,000 in our retirement account and you are contributing $3,600 per year($300 per month). Lets say its invested and averages 8% return per year for the next 35 years. Your account would be worth nearly $1.36 Million. The crazy part, is that $1.18 million of that is from the growth! That’s what we call compound interest.
Now what if you took out $40,000 to pay for something rather than finding another solution. That would mean you now have $10,000 in your account, right? Lets use the same scenario as above accept start with $10,000, how much would you have in 35 years? About $768,000. So taking out that $40,000 now will cost your future self almost $600,000.
So I hope this helps and gives you some reasons why you should try other ideas before dipping into your retirement account. Get another job, sell your moped, negotiate the debt, etc. I don’t know what applies to your situation but what I am saying is try to avoid taking from “future you” in order to pay for mistakes made by “past you.” Don’t compound it with another mistake.
If you have questions about that, other financial planning questions you have interest in investing in alignment with your Catholic values please reach out.
God Bless,
Phil Francois, CFP®
https://www.foundationwealthplanning.com/