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It’s not a good sign when people raid their retirement dollars to pay bills, college tuition, or auto repairs, but more workers have been borrowing from their accounts or taking hardship withdrawals over the past few years.

At the end of 2010, 28% of active 401(k) participants had outstanding account loans, and another 7% took early withdrawals.1 In 2011, retirement nest egg account loans rose by 20% across all demographics.2 Although it’s understandable that people might turn to their retirement accounts for a source of ready cash, it is generally not a good idea. Fifty-five percent of employees who took a cash distribution when changing jobs said they regretted having done it.3

Keep Your Money Working

With certain exceptions, a 10% federal income tax penalty applies to early withdrawals (before age 59½) from tax-deferred plans such as IRAs and employer-sponsored retirement plans. That’s a significant deterrent in itself, but the greater penalty could be the loss of future increases needed for retirement.

Consider the impact of a $10,000 early withdrawal from a traditional IRA. Not only could the distribution be subject to the penalty ($1,000) but also income taxes ($2,800 for someone in the 28% tax bracket), which could leave a net amount of $6,200. On the other hand, if the $10,000 principal was left in the tax-deferred account, in 20 years it would have the potential to more than triple, assuming a 6% average annual growth; in 30 years, it might reach $60,000 (see graph). This hypothetical example is used for illustrative purposes only and does not reflect the activity of any specific financial vehicle; actual results will vary.

retirement dollars - early withdrawal example

If you change jobs, you may be able to leave your retirement account monies in your former employer’s plan. Another option is to roll the money to a traditional IRA. A properly executed trustee-to-trustee transfer to your own IRA could help preserve the tax-deferred status of the funds and potentially avoid unwanted current tax consequences and penalties. It may also give you more control of the nest egg dollars, open up additional options, and help you manage overhead costs.

1) Reuters, February 17, 2012
2), January 17, 2012
3), January 26, 2012

Let’s talk about your retirement planning options. Contact me for a free consultation (866) 471 7233.