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Need Cash? Avoid Tapping Your Retirement Account

March 24, 2021

Imagine if your 35-year-old self magically appeared in front of you one day and asked for a percentage of your retirement savings or a bit of your retirement income. While this would never happen, something financially analogous happens in the lives of too many people. They withdraw assets from their retirement accounts in mid-life, which can hurt their lifetime retirement savings potential (and possibly, their retirement income potential as well). In effect, they borrow from their future selves when they take retirement plan distributions too early. 

Most people who turn to retirement savings for cash do so in response to a pressing financial need, perhaps not fully realizing the negative effect the drawdown could have on tax-advantaged compounding. Loans can be another negative. Is it possible to borrow up to 50% of the invested assets in some retirement accounts, and even more under certain hardship circumstances declared by the federal government in response to a disaster or emergency? Usually, retirement plan loans do not trigger the penalties and taxes common to early retirement plan distributions, but they handicap your potential to amass retirement savings in the same way, by taking money out of a vehicle where it might grow and compound minus annual taxation. Fail to pay such a loan back to the plan on time, though, and you might face a 10% early withdrawal penalty and taxes on the amount not repaid soon enough.1