Apr 24, 2008 11:00 am US/Eastern
Early 401k Withdrawals Come At High Cost
BOSTON (WBZ) ―
In these tough economic times, many people are looking for a way to get out of debt. One growing trend is to tap into retirement savings early. While that might prevent an immediate financial disaster, experts say it comes at a high cost.
At an increasing rate, consumer are making what are called hardship withdrawals from their 401k plans..
"With increased unemployment rate, the downturn in home value and home equities, I'm pretty sure that's driving a lot of those increases," explained Rick Meigs, a 401k consultant.
Experts like Mary Jo Harper of Merrill Lynch agree this is a troubling trend. "A hardship withdrawal is something you want to consider as your last alternative."
Under the law, an investor can only make a withdrawal for specific hardships, such as medical expenses, college tuition, or potential eviction or foreclosure. "The IRS and Congress don't want people depleting their retirement accounts for frivolous reasons," said Meigs.
It is also costly to tap into these funds. Take, for example, a worker who is pre-retirement age, in the 25% tax bracket, and needs to make one of these withdrawals. Not only did he lose the opportunity for the funds to continue growing, but he will be hit with a $5,000 federal tax bill. It's also probable that there would be about $2,000 in penalties.
"You're only able to keep $13,000; very painful, very painful," said Mary Jo Harper.
There are some other options consider. Loans against a 401K are a possibility, as are re-finacing a home or taking out a home equity loan. Mary Jo Harper says the first step is to meet with your financial advisor. "Look at all your liabilities, looking at all your assets, shaking every tree possible."
If the withdrawal is your only option, keep this in mind: the law prohibits new 401K contributions within six months of a hardship withdrawal. Also, not all 401K plans allow these types of withdrawals, so check with your company's administrator.
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