Forgive me Suze Orman, for I have sinned. I withdrew money early from my 401(k).
Oh, it’s not like I wanted to. It’s not like I didn’t explore other options first. It’s not like I used it for something fun like a vacation or a new gourmet kitchen.
Nope. My husband took an exciting job in another state, and with two kids ensconced in high school, we didn’t feel it was the right time to uproot our whole family. So after years of supporting two households, we were drowning in credit card debt. In desperation mode, I cashed out some of my 401(k) to pay down the balances on high-interest cards.
And it seems I’m not the only one.
According to financial website HelloWallet, more than 25% of American households that use a 401(k) or similar plan have withdrawn or borrowed money from their retirement plans for non-retirement spending; over 50% used it to pay off loans, bills and debt.
Overall, those withdrawals add up to a whopping $70 billion annually.
“In effect,” says Stephen P. Utkus, director of retirement research at Vanguard, “[retirement plans] have become dual-purpose systems for retirement and short-term consumption needs.”
Yeah, I got slammed with a 10% penalty, and I’ll have to pay taxes on the withdrawal next April. But for us, saving money for our future wasn’t really an option while we were struggling to pay our bills. Besides, my credit cards were charging more in interest than my plans were yielding.
While I wasn’t able to avoid a penalty, perhaps you can. Here are three penalty-free ways to dip into your retirement plan early.
If you have a Roth IRA that’s at least 5 years old, consider dipping into that before your 401(k).
You can make an early withdrawal from your Roth IRA contributions at any time, for any reason. Because the money is taxed before it’s deposited, you won’t get hit with taxes if you’re only withdrawing what you put in.
If you decide to take out more money than just your contribution amount, the IRS may waive your taxes and penalties if the funds are used for things like helping you buy your first home or pay for college.
You can borrow up to 50%, or $50,000, of your account balance from your employer-sponsored 401(k) penalty-free (and sometimes tax-free), but certain conditions apply.
Hey, Uncle Sam has a heart — even if it might be two sizes too small. Depending on the type of retirement account you have and your reason for accessing it, you may qualify for a penalty-free withdrawal. For instance:
Jeff Rose, a certified financial planner who runs Goodfinancialcents.com, explains how his father-in-law withdrew money from his 401(k) early when his company went through a buyout and he was offered an early retirement package at age 55.
“We ended up taking a distribution from his 401(k) to have some cash on hand and then rolled the rest into his IRA,” Rose said.
No matter how serious your financial situation, withdrawing early from your retirement account should never be your first (or second or third) option. The penalties, taxes and loss of growth are good reasons to first think about getting a low-interest personal or home equity loan.
You can also work with your credit card companies to lower interest rates if consumer debt is your undoing. Another no-brainer: Stop making contributions to your 401(k), and instead, sock the money away in an emergency fund.
The bottom line: Your retirement plan isn’t a piggy bank. And the more money you take out now, the less money will be compounding for your future.
But if taking from your retirement fund is your only way out of a financial jam, don’t be afraid to take the plunge. If you’re smart about how and when you do it (a financial planner can help), you’ll minimize or even avoid the damage and emerge in even better shape to save for your future.
Disclaimer: This article contains general information and explains options you may have, but it is not intended to be investment advice or a personal recommendation. We can't personalize articles for our readers, so your situation may vary from the one discussed here. Please seek a licensed professional for tax advice, legal advice, financial planning advice or investment advice.
Donna Christiano Campisano is a freelance writer who sleeps better at night now that she isn’t facing financial oblivion.