Provided by: Michael Ball, Edward Jones Financial Advisor
You contribute to an IRA and 401(k) to help build the financial resources you’ll need to enjoy a comfortable retirement. But despite these funds being set aside for retirement, many investors use them before they retire. More than half of Americans tap into their retirement savings early, according to a survey from Magnify Money, a website focusing on financial topics. How can you avoid this problem?
It’s obviously important to leave your retirement savings untouched, as much as possible, until retirement. You could spend two or three decades as a retiree, so you’ll need a lot of financial resources. Of course, it’s understandable why some people touch their retirement accounts early: According to the Magnify Money survey, about 23% did so to pay off debts, 17% to make down payments on a home, 11% to pay for college, and the rest for other reasons.
While you also might consider these needs for taking an early withdrawal or loan from your retirement account, you’ve got good reasons for not touching your IRA or 401(k) before you retire. First, you may face tax penalties if you withdraw money from your IRA and 401(k) before 59 ½, though there are exceptions. Also, if your withdrawals from your retirement accounts are large enough, they could push you into a higher tax bracket. Plus, the longer you leave your money intact, the more you’ll probably have when you need it in retirement.
Let’s use the survey results to look at some additional points you might evaluate before using funds from your retirement accounts for other purposes:
• Paying off debts – You could consider using a 401(k) loan to pay down some high-interest rate debt, but this move assumes two things – one, you don’t plan on taking on additional high-interest rate debt, and two, you plan on repaying the loan from your 401(k) within five years. If you don’t, you could face penalties.
• Making a down payment on a home – The IRS allows first-time home buyers to make a penalty-free withdrawal of $10,000 from an IRA to make a down payment on a home; however, taxes could still be owed. You might be better off by delaying the purchase of a home, giving you time to build up additional savings, held outside your retirement accounts, that could be used for the down payment.
• Paying for college – If you haven’t saved enough for a child approaching college, you might consider withdrawing from your retirement accounts to do so. If the funds are used for qualified education expenses, you may be able to withdraw from you IRA without paying a penalty, but again, taxes could be owed on the withdrawn funds. Alternatively, if you have more time, you could consider opening tax-advantaged 529 accounts for younger children to help pay for their education.
As the name suggests, a retirement account is designed for retirement, so do whatever you can to protect it. You may want to consult with a financial professional for guidance on meeting the other needs people cite in tapping into their retirement accounts early. The more you know, the better prepared you’ll be to make the best decisions you can for your situation.