When faced with a financial crisis, it is tempting to look to your long-term savings to ease the immediate burden. However, the solution might be worse than the problem. Tapping your retirement money early could tarnish your “golden years.” In addition to causing stress, cashing your retirement plan early is costly.
If you withdraw money from your 401k, you will likely have to pay tax plus a 10 percent penalty on any money withdrawn. This total tax bill will probably come to about 37 percent of the money you withdraw. Even your credit card companies don’t charge an interest rate that high. As an example, if you withdraw $10,000, you will probably only realize around $6,300.
Borrowing money from your 401k account can also be a risky move. Long-term plan loans usually charge the prime interest rate plus one or two percentage points. In fact, it could cost you more than the stated rate. Say you borrow from your plan at 7 percent but the cash you pull out has been earning 9 percent in the stock market. You are losing out on the additional earnings and future compounding on these lost earnings. Another potential problem is that if you quit or lose your job, your loan may be due immediately. This would be at a time you are least be able to pay back the loan.
Before you put your financial future at risk, consider the following alternatives.
–Borrow from yourself. While cashing your IRA is not desirable, you might be able to take a short-term loan with no penalties. The only requirement is that you pay back the entire amount borrowed within 60 days.
–Take a good look around you. Most likely, there are many things in and around your home that you could sell for cash. Also, if you have the room, consider taking on a boarder.
–Seek employment. Secure a temporary job to help you through this set-back; even if it is not in your field of expertise.
–Use all available resources. Research all sources of cash. For example, you may have a life insurance policy with a cash value. Collect on monies lent to family and friends.
Finally, if you must access your retirement funds, consult with an accountant about your rights and responsibilities. The IRS does recognize some legitimate reasons for hardship withdrawals. The person applying for a hardship withdrawal must show an “immediate and heavy financial need” and have no other source of cash.