retirement

The Cost to Crack Your Nest Egg

Whether you're an early bird or a late bloomer when it comes to saving for retirement, don't scuttle your plans by raiding your nest egg prematurely.

Most 401(k) plans allow participants to borrow up to half of their account balance (but not more than $50,000) and repay the loan over five years. But that can take a big bite out of your future savings because any money you withdraw loses the power of compounding.

In addition, if you change or lose your job, the loan is due immediately. Fail to repay it and the money will be treated as a distribution that is subject to state and federal income taxes, plus a 10% early-withdrawal penalty if you are younger than 55. Some plans offer hardship withdrawals that do not have to be repaid, but they're still subject to taxes and a penalty that can wipe out up to half of your distribution.

You can't borrow from a traditional IRA, but you can withdraw your money at any time. However, you'll pay taxes on the withdrawal and, if you are younger than 59, a 10% penalty, too. If you have a Roth IRA, you can withdraw your contributions (but not the earnings) at any time tax-free and penalty-free.

Gregory Dyson, senior vice-president of marketing for ICMA-RC, which provides retirement-related services to state and local government employees, gives this example of the long-term impact of premature withdrawals.

Let's say you are 35 years old and have a retirement-account balance of $30,000. If you take a $15,000 hardship distribution, it would cost you more than $122,000 in lost savings over the next 30 years, assuming an average annual investment return of 7%. "That's a very high price to pay for a short-term fix," says Dyson.

If you're really squeezed for cash and feel you have no choice but to cut back on your savings, at least try to contribute enough to capture your employer's match. Otherwise, you're walking away from free money.

A recent evaluation of nearly one million 401(k) participants by Financial Engines, a leading provider of investment advice and managed accounts, shows that one-third of workers failed to contribute enough to capture the full company match. With depressed stock values, you'll have the added advantage of being able to buy more shares at lower prices.

Most Popular

House Approves $3,000 Child Tax Credit for 2021
Coronavirus and Your Money

House Approves $3,000 Child Tax Credit for 2021

The proposal would temporarily increase the child tax credit to $3,000 or $3,600 per child for most families and have 50% of it paid in advance by the…
February 27, 2021
Third Stimulus Checks Are One Step Closer to Reality – How Much Will You Get?
Coronavirus and Your Money

Third Stimulus Checks Are One Step Closer to Reality – How Much Will You Get?

The House passed President Biden's $1.9 trillion stimulus package. While the bill faces hurdles in the Senate, the provisions authorizing another roun…
February 27, 2021
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021

Recommended

8 Insurance Products You May Not Need
Financial Planning

8 Insurance Products You May Not Need

You may be paying for insurance, such as long-term disability or product warranties, that is potentially unnecessary.
February 26, 2021
Roth IRA Basics: 11 Things You Must Know
Financial Planning

Roth IRA Basics: 11 Things You Must Know

A Roth IRA can be a great way to save for retirement since the accounts have no required minimum distributions and you withdraw the money tax-free.
February 25, 2021
33 States with No Estate Taxes or Inheritance Taxes
retirement

33 States with No Estate Taxes or Inheritance Taxes

Even with the federal exemption from death taxes raised, retirees should pay more attention to estate taxes and inheritance taxes levied by states.
February 24, 2021
Buying a Burial Plot Is a Grave Decision
Financial Planning

Buying a Burial Plot Is a Grave Decision

Thinking about buying a burial plot can be uncomfortable but making this purchase ahead of time has its advantages, including potentially saving you m…
February 17, 2021