When you’re short on money – whether it’s due to unemployment, illness, or just the urge to buy a new motorcycle – it’s easy to start eyeing your retirement funds.
After all, you’ve been contributing to them all these years. And it’s your money.
If your account has gone up in value – lucky you – it may seem like you can afford to take some out early.
On the other hand, if you’ve watched your account go down, it’s easy to think it doesn’t make any difference. Why even try? Why not take a withdrawal and use your money now?
There are plenty of reasons why you should leave that money right where it is:
If you haven’t reached age 59 ½ yet, you may have to pay a 10% penalty on the money you withdraw.
There are exceptions.
You may avoid the penalty if you are totally and permanently disabled, you have very significant medical expenses, you use the money for higher education, or you use the money to pay for health insurance when you are unemployed, for example.
Unfortunately, penalties aren’t all you have to worry about when you take money out of a traditional retirement account.
2. Income tax
You’ll probably also have to include the withdrawals as income on your tax return.
If you take a significant amount of money out at once, the withdrawals could push you into a higher tax bracket.
In addition, you could lose the benefit of certain credits and deductions.
You must pay income tax on withdrawals from traditional retirement accounts, even if you are over age 59 ½.
Depending on your other income and deductions, you could end up paying 25% or more of the withdrawal in income tax.
If you’re also paying a penalty, taking money out early starts to seem a lot less attractive. There’s not much left!
If you wait until retirement to withdraw money from your retirement account, you’ll still have to pay income tax.
However, most people are in a lower income tax bracket after retirement.
Withdrawals from a Roth IRA or similar retirement account are not subject to income tax.
3. Time value of money
The beauty of compound interest is the way it makes your investment grow over time.
However, it takes a lot of time for compound interest to work.
If you put $10,000 into an account at age 40, and you get a 6% rate of return for the next 25 years, without adding any more to the account you’ll have $42,919 when you retire at age 65.
If you wait until age 50, however, that same $10,000 investment will only be worth $23,966 when you’re ready to trade your commuting car for a golf cart.
Taking money out of your retirement fund, especially on a repeat basis, is like starting over.
It’s just going to be that much harder to collect enough money for when you need it.
4. Retirement funds are legally protected
If you hit hard times financially; for example, if you get behind on your mortgage and other bills, your creditors may be able to take you to court and attach your assets, such as your bank accounts, investments, and wages.
However, in most cases they can’t get to your retirement accounts. They’re safe.
That’s why a financial crisis is usually the last time you should drain your retirement accounts.
If your finances are headed down the drain, don’t send your retirement money with it.
5. Retirement funds are for retirement
This is the most important reason of all.
Too many people are still not saving enough for retirement.
In fact, a survey by the Consumer Federation of America and the American Savings Education Council found that only 49% of non-retired respondents feel they are saving enough for retirement.
Unless you can work forever, you’d better stay on good terms with the in-laws – when you’re living on Social Security benefits, you may need their spare bedroom.
Better yet, find some other way to make ends meet during your working years.
You put money away for retirement, and that’s what it’s for.