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The True Cost Of Withdrawing Early From Your 401(k)

The True Cost Of Withdrawing Early From Your 401(k)

| August 07, 2020
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Although the American Dream means different things to different people, one universal desire is to enjoy a satisfying retirement when our working days are over. Making this dream a reality is no easy task, but there’s nothing more resourceful than a 401(k) to help you inch closer to reaching that goal. And if your employer is contributing funds to make this nest egg grow even more, all the better! 

But at the same time, we are painfully aware of how unpredictable life can be. What if something crazy happens and you need cash—and you need it now? If you’re tempted to crack open your retirement piggy bank early to help out with some pressing expenses, we urge you to read this first.

You may have heard that if you touch your 401(k) before age 59½, you’ll be hit with income taxes and a 10% early withdrawal fee. What you may not realize is how significant of a hit this is in the grand scheme of things—and you’re not alone. In fact, about 1 in 3 investors have taken withdrawals from their 401(k) before age 59½ (usually when changing employers), and it is taking a huge toll on their future retirement situation. (1)

Today, we’re here to give you a reality check. If you are considering cashing out your 401(k) early, consider the following, think twice, and take the time to search for alternatives.

The Immediate Consequences Of Cashing Out Your 401(k) Early

Let’s look at a hypothetical example. Bob is 40 years old, runs into some financial trouble, and decides to cash out the $50,000 he has saved over the past 20 years. 

Bob understands he’ll have to pay some penalties and taxes, but he doesn’t take the time to actually run the numbers. He makes the withdrawal, checks his bank statement, and is shocked at what he sees. 

After paying 24% in federal income taxes, 6.5% in state income taxes, and a 10% early withdrawal penalty, Bob’s $50,000 has dwindled to $29,750—just over half of his original 401(k) savings. 

And those are just the immediate consequences.

The Long-Term Consequences Of Early Withdrawals

Bob also just erased all his momentum from 20 years of tax-free growth. He was at the point where his account was starting to snowball. He was earning interest off his interest. Now he has to start again from scratch; and at age 40, he has a lot less time to rebuild that snowball effect.

Even worse, after realizing he made a huge mistake, Bob did some investigating and realized he had other options available to him. It turns out that the withdrawal (and all the consequences) wasn’t necessary after all. 

It was a costly mistake that could have been avoided. 

Don’t Make Bob’s Mistake

It’s hard to make rational decisions when emotions are running high, so before you make any rash decisions, we highly recommend speaking to a financial advisor. If you ever find yourself in a tough spot financially and are considering cashing out your 401(k), let us help you navigate your other, less financially devastating options (such as taking a loan for your 401(k) or taking a hardship withdrawal). 

If you have questions about cashing out your 401(k) or you’re interested in creating a personalized financial plan to help reach your goals, our team at Setchfield Asset Management is here to help. Schedule an introductory meeting to see if we are the right fit by emailing me at steve@setchfieldam.com or calling (303) 627-1099.

About Steve

Steve Setchfield is Chief Investment Strategist at Setchfield Asset Management, an independent financial advisory firm. With almost 30 years of experience, Steve serves his clients by keeping them out of financial trouble in volatile markets, using a low-key, rules-based approach to investing and helping them with every aspect of their financial lives. Steve studied finance at the Metropolitan State University of Denver and spent several years working at Shearson Lehman Brothers and Kemper Securities before founding his own independent firm so he could offer objective, personalized advice and strategies. Steve is a Colorado native and enjoys skiing and other outdoor activities. He spends his free time volunteering for Big Brothers/Big Sisters of Colorado and coaching wrestling in the Cherry Creek school system. In 2003, Steve was a living kidney donor for his uncle who suffered from polycystic kidney disease. To learn more about Steve, connect with him on LinkedIn.

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(1) https://www.fidelity.com/viewpoints/retirement/cashing-out

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