Consider the costs of tapping a 401(k) or IRA before age 59½ and explore your alternatives.

There are times when it’s tempting to use retirement savings early. To cover an emergency, for example—but doing so could cost more than you think. Before you tap into your 401(k) or IRA, make sure you know the consequences as well as other options that are available.

Early withdrawal results in more than one financial hit

The rules for retirement accounts are designed to incentivize saving and discourage early withdrawals for good reason: so the money—and its earnings—are there when you’re older.

The incentive is deferred taxes on the income and earnings until withdrawals in retirement. 59½ is the age at which you’re allowed to make withdrawals from retirement savings without penalty (although you’re not required to).

Take the money out before age 59½  and you’ll owe taxes plus a penalty of 10%. (An exception to this rule was made as part of the 2020 CARES Act, but it expired at the end of last year.)

Another financial hit is from lost earnings. Even if you take the money out as loan and repay your retirement account, you miss out on the earnings potential of those funds while they were withdrawn.

You also miss out on the compound growth of earnings. Even taking out a small amount has big consequences. Think about this: $500 that earns 7% for 25 years and is compounded monthly grows to $2,862.71. That’s over five times the original amount! Considering the fact that the stock market’s annualized return for the last 50 years has been 10.9%, you could be losing a lot more.

Consider the alternatives

As shown above, early withdrawals from retirement savings can be costly. Before you make such a move, consider the alternatives.

Purpose                                            Alternative(s)                                              

cover an emergency                        personal loan, HELOC, credit card

buy a house                                      mortgage, save up for it

start a business                                 personal loan, HELOC

pay tuition                                         student loans, scholarships, grants

pay down debt                                  personal loan, HELOC, cut spending

buy something you want                 personal loan, HELOC, credit card, save up for it

Should you ever use retirement funds early?

The decision to take early withdrawals is very personal and ultimately only you can make the call.

In very limited circumstances, the IRS allows early distributions for hardships. However, the rules are very tight and specify that the distribution is for an immediate, heavy financial need and is limited to the amount necessary to satisfy that financial need.

Get help from our team

The team at Consumers is here to help you savings reach your financial goals and grow your retirement. Check out our retirement planning services online or give us a call at 800-991-2221.

Consumers provides banking services for more than 100,000 members. If you have banking questions, call us at 800-991-2221. We make it easy to bank how you want, when you want.

Federally insured by NCUA