Individuals must learn how to manage their finances in a way that takes into consideration short, mid and long term goals. A short term goal might include building an emergency fund in a savings account to which you have instant access. Mid term goals might include saving for a car or down payment for a house. Long terms goals of course involve saving money for your retirement years.
As you might guess with each goal, different savings strategies must be considered. If you fail to use the right strategy you may end up losing a significant portion of your savings. This is the case when you invest money in your future via a retirement plan and then tap into those resources for financial needs that arise before you retire. Since most retirement plans are by design intended for long term investments, the penalties and consequences of taking your money early can be significant. Here we look at a few of the negative consequences that go hand-in-hand with early distribution of retirement funds.
Why You Should Leave Your Money in Retirement Accounts
- Early withdrawal penalties. With any retirement savings plan that limits withdrawals to those who have reached age 59 1/2, it is important to avoid taking money before that age. If you do, you will be slapped with an early withdrawal penalty of 10%. If this was the only penalty, one might be willing to take the hit to their finances in order to access their cash early, however it is only the beginning of possible penalties.
- Pay attention to loan provisions. You might be tempted to access the money in your account due to the ease at which you can do so. As a general rule, companies do not set restrictions to how you can use your own retirement money as long as you are willing to repay the money as set forth by the plan. In most cases you can borrow up to half of your contributions (not to exceed $50,000) with five years to repay the money. Since you are basically paying yourself back, this might seem like an viable alternative to a traditional loan, especially considering the attractive interest rates. The downside of this option is the fact that should you lose your job your loan must be paid back in full immediately. In this struggling economy where no job is safe, this is a risk best avoided whenever possible. See these articles for more information about 401k loans and TSP loans.
- Loss of growth opportunity. Regardless of how or why you might tap into your retirement account, one of the biggest negatives is the loss of growth opportunity. What many people do not think about when borrowing from their 401k is how much that money could be working for them if left alone in the account. For this reason you should really consider the bigger picture before taking money from your retirement account that could be of better use right where it is.
Most people will agree that while accessing money in a retirement account could certainly help improve their personal finances in the short term, in almost all situations it is better to leave that money in the account and look for alternatives to borrowing from your retirement. What seems like a great idea today might not be such a good idea in the long run.
