Consider these five questions before you withdraw early from your retirement account.
Financial stress is real right now. Maybe your job’s been affected, or unexpected health expenses have popped up. The kids are home for the holidays, and it feels like there’s a lot to juggle. You’re not alone—Vanguard Group saw early withdrawals from 3.6 percent of their 5 million customer accounts 2023, up from 2.8 percent in 2023.
A question I hear often as a financial coach is whether it’s smart to dip into your retirement account, such as a 401(k). While it might seem tempting, here are five crucial questions you should ask yourself before deciding to withdraw or take out a loan from your retirement plan.
If you answer “no” to any of these, it’s probably best to look into other options outside of a retirement withdrawal that could save you from more financial stress down the line.
Is This Retirement Withdrawal Absolutely Necessary?
I’m often surprised to see many of my financial coaching clients who are contributing to their retirement accounts such as their 401(k) while also racking up credit card debt to pay basic bills.
If you’re finding it hard to cover essential expenses like food, housing (mortgage or rent), utilities, transportation, and health, rather than withdraw, it likely makes sense to pause your retirement contributions first if you are struggling to pay for basic necessities.
If you’re at the age of being able to pull from your retirement without penalty through strategic withdrawal strategies, it can make sense. But if you are not at retirement age and thinking about it to fund a non-essential purchase, consider the long-term cost of delaying your retirement versus the short-term gain of withdrawing early with potential penalties.
Are You On A Consistent Monthly Budget Before You Withdraw From Retirement?
Many people withdraw or take loans without truly understanding how much they need. Not having a consistent monthly budget, as boring as they are, have long-term consequences on your lifestyle later. To minimize the impact, you need a clear routine for your monthly budget.
You may have avoided budgeting because you’ve treated it as a tracking exercise rather than a planning exercise. I teach a simpler way of budgeting that only requires three categories — strive, revive and survive to help you avoid the drudgery of spreadsheets and tracking every penny.
This habit helps you decide if you need to withdraw any money at all, and if so, exactly how much. I’ve worked with several clients who figured out after being on a budget for a few months, that they had more money at their disposal than they initially thought.
Do You Have A Plan For Your Retirement Withdrawal Penalties and Taxes?
The money you withdraw is considered income and your tax rate will depend on your total taxable income for the year. You’ll at least pay federal income tax on the amount you withdraw.
Even if you can spread out payments over future years, you need a solid plan to handle this tax bill to avoid additional stress.
How Will You Pay Your Retirement Withdrawal Back?
Your 401(k) is designed to fund your retirement. If this is a short-term solution, do you have a strategy to earn more or save more to replenish the funds you’re withdrawing now?
Before touching your retirement funds, consider other ways to flow more cash:
- Can you negotiate more pay at work?
- Can you delay some short-term expenses until you’re back on track?
- Can you negotiate any bills like your insurance?
Withdrawing early means you might need to work more years or save more later to make up for the shortfall.
Is A Retirement Withdrawal Your First Resort Or Your Last?
Right now may feel like stressful time, and it’s natural to want immediate relief. But building a financial future is a marathon, not a sprint. Reconsider why you started your retirement account in the first place.
Pulling funds early interrupts your investments’ ability to compound growth, potentially costing you thousands of dollars. Explore alternative funding options before tapping into your retirement savings can give you peace of mind that you’re not sacrificing your future self.
A retirement withdrawal should be a last resort, not your first move if you are not yet at retirement age. Keep these questions in mind to make the best decision for your financial future.