When the economy is in rough shape and cash gets tight in many households, some workers choose to ease the burden by dipping into their nest egg early. Others may want the money to put into an IRA or another type of account.
There are a few extenuating circumstances in which an individual will be permitted to withdraw some or all of the money in their 401(k) plan. But you might want to think twice about cashing out a 401(k); it can be a serious detriment to your financial situation for several reasons.
For starters, it’s a short-sighted plan. Every dollar that you withdraw from your 401(k) is a dollar that is not gaining returns. Contributions to 401(k) plans and IRAs are not subject to taxes, so you are essentially giving up a large tax break by withdrawing your money early. Furthermore, after being granted a financial hardship withdrawal, the IRS will prohibit you from contributing anything back into the plan for at least six months. Therefore, you’ll also miss out on 401(k) matching from your employer.
But you won’t just fail to earn money; you’ll also lose money through penalties and taxes. Early withdrawals from a 401(k) plan, with a few rare exceptions, are subject to a 10 percent tax. In addition, the money that you receive counts as income, so it may bump you into a higher income tax bracket and cost you even more. You could withdraw a few thousand dollars to make ends meet but easily lose a large percentage of that. Your financial situation may seem dire, but you’ll be no better off in the long run by letting your money vanish into thin air!
Cracking into your 401(k)
Cracking into your 401(k) early might seem like a quick and easy solution to your financial woes, but keep these caveats in mind before doing it. Ask yourself if the penalties and taxes are worth it. Even in the most desperate situation, you are still setting back your retirement goals and throwing your money away. You’ll be missing out on tax breaks, 401(k) matching, and all of the other benefits of saving money in a 401(k). The money still belongs to you, but cashing out a 401(k) is something that should be avoided at all costs.