It can be difficult to look at the money in your 401(k) account and realise that you can’t touch it for many years to come. Whether you want to buy a new toy, or you’ve hit some financial strife having money that’s yours but not yours is a frustrating feeling. As much as it seems like a great idea to pull some of the money out early, there are reasons why you should leave it alone as long as possible.
Early Withdrawal Penalties
If you attempt to withdraw from your 401(k) prior to age 59 and six months, you’re subject to federal taxes and in many cases a 10% penalty. If you’re under 60 and withdraw $100,000 from your 401(k) account, you will only get to keep $75,000 of that if you are in the 15% federal tax bracket. In one transaction you’ve lost 25% of your money.
Cheating Yourself Out of a Cushier Retirement
If you pull money out of your 401(k) early, you might be cheating yourself out of a cushy retirement. $100,000 left alone for 10 years with a 7% return will be worth over $200,000. Once you reach an age where you can withdraw this without penalties the required minimum distribution for $200,000 is $8,000 a year, though you can take more.
While you might be the type of person to withdraw from your 401(k) and invest it elsewhere, studies of human psychology show us that once people have money in their hands they spend it. The best choice is to leave your retirement accounts alone for as long as possible and allow compound interest to work on them to ensure you have a comfortable nest egg when you retire.
Rolling Over to Other Accounts
Many people withdraw from their 401(k)s because they change employers, or want to access the money at a younger age.
If you switch employers you can roll your current 401(k) balance over to your new employers plan with a few forms. As long as this is done within 60days of changing employers, you won’t pay any fees.
Another option is to roll your 401(k) account over to an Individual Retirement Account (IRA). An IRA account is not tied to an employer and stays with you regardless of who you work for, but check the fees and charges before making the switch. A 401(k) might still be the better choice for you.
If you really desperately want to pull money out of an IRA or 401(k) early there are ways you can do it without paying a penalty, but it requires a lot of pre-planning. Any amount converted from a traditional IRA to a Roth IRA can be withdrawn penalty and tax free five years later. It won’t help you today to buy a new car, or fund a down payment for a house, but might make all the difference in your long term plans.