You May Want To Reconsider Your Decision
When the economy slows down, money is tight. Many people are having a hard time making ends meet. You may be at wit’s end yourself on where to find some extra money to get by.
One source of money that keeps popping into your head is your retirement plans. You can’t shake it, you keep thinking about tapping into your retirement plans to pay your bills; but should you, is it a wise financial decision?
Well you think it is. You have logically thought it through: the money in your retirement plan is just sitting there, you are only in your 30’s or 40’s, not retiring soon, so why not cash those retirement plans in? For many financial reasons, you may want to rethink that logic.
Cashing In Your Retirement Plans For Money
There are advantages and disadvantages to cashing in your retirement plans, mostly disadvantages.
#1 – You Will Pay
If you close your retirement plans or cash them in before age 59 1/2 the IRS considers that a distribution and distribution rules will apply.
You will incur a 10% penalty and pay income taxes on the amount of the withdrawal. The IRS will allow you to avoid the penalty if you use the money for one of the following reasons: to buy a primary residence, to prevent foreclosure on your primary residence, to pay for tuition costs, funeral expenses, or medical expenses. You will not avoid paying the taxes just the 10% penalty.
#2 – You Will Forfeit Your Future
By dipping into your retirement plans to pay for today’s expenses you are forfeiting your financial future. Closing your retirement plans is a big long-term financial mistake if you ever want to retire.
Your retirement plans are not savings accounts. The purpose of investing in retirement plans during your working years is so that you can finance your retirement years. By cashing in those retirement plans before retirement age, you are missing the opportunity to pay-forward your retirement.
#3 – You Lose Protection
When your money is in a retirement plan, those assets are protected from creditors. That is a very nice benefit. Creditors can ask you but not force you to cash in your retirement plans. You cannot beat that protection.
Your Other Options For Money
A Retirement Plan Loan
A better financial move may be to borrow from your retirement plans instead of cashing them in. The interest rates on retirement plan loans are generally minimal and the payback schedule is usually fair.
The only way you will be charged the 10% penalty and be hit up for income taxes is if you fail to repay the loan. A retirement plan loan that is defaulted on is considered by the IRS to be a distribution; and distribution rules will apply.
Another option you have when needing extra money to pay for current expenses is your current retirement plan contributions. You can stop them, that will give you extra money. When you get your finances back on track, you can start making contributions again.
All you lose is the growth of your retirement account; you do not incur any extra taxes or penalties.
Back in the 1980’s the 401k retirement plans were designed with one purpose in mind, to help individuals save for their own retirement. Congress probably knew back then that social security would not survive as promised.
These retirement plans were not designed to pay for current expenses; so penalties and taxes were included to discourage folks from making withdrawals before their retirement years. Make a good financial decision about your retirement plans, use them for the purpose they were designed for. Find other sources of money if you hit hard times.