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Posted on August 23, 2008

Simple Advice on Tapping Into Your Retirement Fund Early: Don’t

It’s no secret that the economy is currently in the midst of a slowdown. How serious is it? The old joke about the difference between a recession and a depression comes to mind: If your neighbor’s out of work, it’s a recession. If you’re out of work, it’s a depression.

Regardless of what you call the current economic situation, you may find yourself short of cash and looking around for a place where you can make up the shortfall. Then, a statement from your 401(k) or 403(b) plan arrives in the mail, and you think: hey, there’s tens (or hundreds) of thousands of dollars “just sitting there.” If I could just take a little out now…

Personal finance expert Dan Solin thinks this move is so unwise that he’s incorporated it into his list of “12 dumb money moves.”

The reason is simple: the tax consequences are terrible. As Solin points out, close to half of the money you withdraw can end up gobbled up by taxes, so the end result is that you’ve just “donated” a large portion of your retirement money to the IRS.

Beyond this, you’re going to need your retirement funds when you retire. The average yearly Social Security benefit is only $13,000, so unless you want to live at poverty level, you’d better save now. The beauty of 401(k)’s and 403(b)’s is that the money can accumulate without being taxed. But when you raid your retirement plan, you not only lose the money you took out. You also lose all future earnings.

You can borrow from some retirement plans without tax consequences. This is obviously better than making a withdrawal. But think long and hard before you decide to do this; and think of it as borrowing money, not as merely tapping into what’s already yours—it won’t be once it’s spent. If you’re having trouble making ends meet now, won’t it be all the harder to make loan payments on top of everything else? Case closed.

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