We know you shouldn’t take money early from your tax deferred retirement account. So why do it?

Retirement


Morley Stettner

When you earn money, it’s normal to want to spend it. There’s nothing wrong with that, unless your account is tax-friendly.

Most employees with 401(k) or other defined contribution plans want to build a nest egg. They allocate part of all their salaries to it and leave it alone. All the more so if their employers are commensurate with their contributions.

But when they leave their employer, they may treat the balance in their retirement account as a ready-to-use cash source. Advisors often urge job seekers to resist the urge. Instead, they are proposing to roll over the funds into another tax deferral vehicle and let it continue to grow.

But many ignore that advice. About 41% of employees who quit their jobs are withdrawing cash from her 401(k).Most of them use up your entire account

The IRS imposes a 10% penalty for withdrawing these funds before age 59 1/2. Some savers don’t realize this until it’s too late. Even if you are aware of the penalty, you may still withdraw cash anyway. This is especially true for young individuals who tend to prioritize immediate spending needs over long-term growth.

“Sadly, long-term thinking can be lacking when you’re young,” says Bob Peterson, a financial adviser in Lake Forest, Illinois. You may think. They don’t realize they can wait and receive a $100,000 check thanks to the power of compound interest and the return on investment.

If you’re under 59.5 and you’re in financial trouble, there are ways to avoid the 10% penalty. Examples include withdrawing deferred taxes to cover unpaid medical bills above a certain level, some higher education costs, and the purchase of your first home.

However, penalties apply in most cases of early withdrawal. Some people are caught off guard. “It feels good even for a short time. [to cash out]However, when you file your federal tax return, you may find that your refund is less than expected or you have an outstanding balance due to fines.

“Your 401(k) administrator may not tell you about penalties when you request distribution,” Peterson said. “Otherwise you may not read the disclosure” and may face a nasty surprise when it comes time to pay your taxes.

As a general rule, anyone under 59 1/2 who is thinking about fiddling with money in a tax-advanced account should avoid online transactions. Instead, call your employer’s benefits manager and talk to them about your options. “Many people are doing rollovers online and it tends to be confusing,” said Tim Ralph, an adviser in Boca Raton, Fla.

A financial planner can help you with that. If you don’t have one, some advisors, especially those looking to build a practice, may offer free introductory consultations.

Some investors are looking to reallocate their retirement savings for riskier bets. They may want to buy real estate, cryptocurrencies, or pursue other attractive possibilities.

“Given the penalties and fees, I recommend against it,” Ralph said. He also adds that such high-risk investments could jeopardize portfolio diversification, which tends to yield higher long-term returns.

However, in some scenarios it may make sense to pay the early withdrawal penalty.

“If you have a lot of credit card debt, you can insist on paying off the debt,” Ralph said. “Many people don’t want to lose 10 percent of their money. [by paying a penalty]But if you pay 10% to get rid of 20% or 24% [credit card interest],” it might be worth it.

If you withdraw your 401(k) balance and regret it, acting quickly can save the situation. Career changers who receive funds from an IRA or other type of retirement plan distribution may transfer the money to another tax-advantaged account within 60 days. Even after the deadline, the IRS may agree to waive her 60-day rule under certain circumstances.

More information: What happens to Social Security payments if no debt ceiling agreement is reached?

Also Read: CDs vs. High Yield Savings Accounts — Where Can You Earn 5.5% After The Federal Reserve Hikes? “This Is Time Sensitive.”

– Morley Stettner

This content was produced by MarketWatch operated by Dow Jones & Co. MarketWatch is published independently of The Dow Jones Newswires and The Wall Street Journal.

 

(Closed) Dow Jones Newswire

05-06-23 1106ET

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