Like a hammer from the sky, a $2,000 bill hits your checking account. You don’t have it, and your savings account is empty. So, where do you get the money?
One option: withdraw from your 401(k). It’s not a great option, but the money is there, and you can use it, despite the consequences — you wouldn’t be the first.
A recent report from LiveCareer (1) says six in 10 workers over 50 are actively withdrawing from retirement plans to cover daily expenses.
Amid the rising cost of living, the motivation to dip into your retirement fund tracks, but there’s a reason financial advisors advise against doing this. Withdrawing early from a 401(k) could cost you an additional income tax of 10% of the amount you withdrew (2).
Luckily, you can avoid early 401(k) withdrawals by doing a few simple things that can make paying for everyday expenses less costly.
You might be putting too much money into your retirement accounts.
“I see a lot of people who are fixated on shoveling lots and lots of money into their retirement accounts,” says Jay Abolofia, CFP, on CNBC Select (3). “I’m all for saving for retirement, but sometimes it’s too much of a good thing. You should be saving elsewhere so you can adjust when life happens.”
If you have money in retirement accounts and nowhere else, rethink any current contributions. By building a modest emergency fund, you could avoid early withdrawal fees.
Even a small account could make a huge difference. Vanguard found that savers with at least $2,000 in savings were 43 percentage points less likely to cash out a 401(k), and 17 percentage points less likely to make a hardship withdrawal (4).
Pressing pause to retirement contributions can feel bad because it feels like you’re dooming your future self. But think of it this way — if your retirement plan is a car, an emergency fund is like car insurance: designed to be ignored 99% of the time, and when you need it, it saves you. A small emergency fund is just another part of your retirement savings.
Run through a checklist of non-retirement accounts you may be able to withdraw from without penalty. This includes HSAs, checking or savings accounts and taxable brokerage accounts.
No money on hand? You still have options.
It might be cheaper to borrow money than withdraw deposited funds. A personal loan could be cost-effective, if you get a good rate. You might consider taking out a low-rate home equity line of credit (HELOC) to cover larger expenses. That said, it’s a good idea to talk to a financial advisor before borrowing against your home.
Merrill Lynch suggests taking out a loan against your 401(k) to avoid the worst penalties (5), though not all plans allow this. If your employer does allow it, you may be required to pay back the whole loan if you leave the company. Not exactly ideal, but potentially much cheaper than dipping into your 401(k) early.
Avoid penalties by withdrawing contributions from a Roth IRA or using special exemptions.
Roth IRAs treat contributions and earnings on those contributions differently. You can withdraw contributions to your Roth IRA without being penalized, at any age, according to Fidelity Investments (6). However, earnings are taxed and penalized if you withdraw them within five years of your first contribution. So you need to be careful not to overdraw.
In some cases, you can withdraw money from a 401(k) without penalty. The IRS lists special exemptions, among them are medical expenses and money needed to avoid being evicted (7).
Thanks to passage of the SECURE 2.0 Act of 2022 (8), you might be able to withdraw $1,000 from your 401(k) penalty-free, for a personal or family emergency. This is doable once a year if you restore the withdrawn funds, or once every three years if you don’t (9).
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LiveCareer (1); Internal Revenue Service (2),(7); CNBC (3),(8); Vanguard (4); Merrill Lynch (5); Fidelity Investments (6),(9)
This article originally appeared on Moneywise.com under the title: Most workers over 50 tap into their retirement accounts — here’s what to do instead of cracking into your nest egg
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