Most personal finance professionals suggest that you do not touch the money in your 401(k) until you have reached full retirement age. However, there may be certain circumstances that will prompt you to think about doing so despite this advice from knowledgeable wealth management professionals. In this case you should at least be aware of the potential consequences of doing so.
Funds can be withheld
If you do decide to withdraw funds early from your 401(k), the Internal Revenue Service (IRS) requires a portion of your funds, 20 percent, be withheld to cover your tax liabilities. In other words, if you are looking to withdraw $20,000 from your 401(k) you will actually only receive around $16,000. But the good news is that you will have a chance to receive some of those withheld funds back when the government sends your tax refund. However, this will depend on how much money you owe when filing your next tax return.
IRS may levy penalties
As the rules stand now, if you withdraw money from your 401(k) prior to reaching the age of 59 ½ the IRS will charge you a 10% penalty. This charge will be applied to the next tax return you file. In other words, if you take out $10,000 you will be charged $1,000 by the IRS.
Less capital for retirement
One consequence that many fail to consider when looking to withdraw early from a 401(k) account is that this will diminish the amount of money, they will have available to sustain themselves during retirement. When you take money out of your 401(k) account you are basically selling stocks and other investments which were meant to continually appreciate in value over the long term. By selling these assets you are missing out on future capital gains which would normally be available to use during your retirement years when you are not working to earn income.
Also, since stock/mutual funds are usually the most predominant holdings in a 401(k), withdrawing early can be particularly consequential. The stock market generally has an upward bias which means that it has been historically more likely to move up than down over longer periods of time. For the most part, the longer you are invested in the stock market the more appreciation you will see from your invested capital.
Withdrawing funds early means you will not be able to obtain these future capital gains that you would have usually earned by keeping your money in the account. This can be even more consequential if you decide to take funds out following a large drop in the market. However, regardless of when you withdraw it will generally result in you having less money to sustain you during your retirement years.
Plan strategically how to use withdrawn funds
Regardless of your reasons for withdrawing funds early, you should at least be aware of these potential negative effects. However, if you do decide to move forward with withdrawing early you should make sure to have a strategic plan on how you want to spend the funds. Make sure to integrate this into your overall family financial planning.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of the author and not necessarily those of Raymond James. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.