piggybankKnow the short term and long term costs before you decide.

Thanks to our slow economy over the past few years, I continue to receive this question from clients as well as neighbors and friends. Times are tough and money is tight. That retirement account you’ve been growing for years becomes more appealing as you scramble to make ends meet every month, especially when there is an unexpected event where quick cash is required.

The short answer is NO

Retirement accounts are for retirement. As a trusted advisor, I first need to state that it’s not a good idea to withdraw or borrow from your future retirement to pay for something now. The money that you remove today impacts when and how you can retire. It is also expensive in several ways:

  1. There may be penalties as high as 10% for withdrawing retirement account money.
  2. The money probably is taxable when you withdraw it, limiting your purchasing power.
  3. You lose the future investment growth potential (tax-free!) of your investment.

The last item above means you will have to save much more in the future to make up the balance. Here’s a quick example.

The future value of a $100K retirement account

Let’s say that you’re 45 and have $100,000 invested in a retirement account with a conservative growth rate of 6%. When you are 65, with no further investment you will have saved just over $320,000. If you withdraw $25,000 of that $100,000 today, by 65 that same account will only grow to just over $240,000. Today’s $25,000 withdrawal will cost you $80,000 at retirement. Taxes and penalties will further reduce the $25,000 withdrawal to $15,000, or even less if you are in a higher income bracket. That’s an expensive withdrawal!

Emergency situations are different

Sometimes you simply need the retirement account money today in order to live and feed your family. Some of our clients have been placed in difficult situations recently and have no choice, like:

  1. Loss of a job with no immediate or interim opportunities. I’m sorry if you’re in this situation.
  2. No bank loans available. You may be able to borrow against your 401k account. See below.
  3. Need to fund someone’s education, it’s too late for a 529 Plan, and you can’t qualify for financial aid. There may be exceptions to the withdrawal penalties for students.
  4. Medical expenses. This is becoming more common as insurance companies limit coverage. Exceptions to the withdrawal penalties may apply here as well.

Borrowing vs. withdrawing 401k and IRA funds

If you must dip into your retirement savings, you may have a couple of options depending on the types of retirement accounts you own. If one of your accounts is a 401k (usually from your employer), you may be able to borrow money without a penalty. You still need to pay back the loan in five years at a 4-5% interest rate, but both the principle payments and interest all go directly back to your account – you’re the bank.

You can technically borrow from an IRA, but you only have 60 days to pay the money back before it is considered taxable. If you are under 59 ½ years old, you may also be hit with that 10% withdrawal penalty.

What about borrowing from your 401k to buy a house? Although there are exceptions to the withdrawal penalties for first-time homebuyers, the money is still taxable, which will limit your purchasing power. With today’s low mortgage interest rates, a bank loan is a better alternative. Or consider borrowing 401K funds just for your down payment.

Seek CPA advice and make the right decision

Before you make an important life decision like this, contact a qualified CPA to discuss your unique situation and options. There may be alternatives that can provide the money you need while minimizing costs and retaining your retirement accounts. There may also be exceptions, like certain long-term medical care situations, where it is actually better to use retirement account money than other funds.

Neal Bach, CPA