The cost of borrowing from your retirement account
When planning for your financial future, it's crucial to account for those little expenses that sometimes blindside you - like medical expenses or car repairs. Sometimes those little expenses turn into big expenses and you need a little more to cover the cost. Maybe you want to buy a house and need a large chunk of change for a down payment. Perhaps you lost your job and need some cash to cover expenses until you can get back on your feet. It can be tempting - if you need a lot of cash - to look at all the money in your retirement plan for a low interest loan. But before you decide to dip into your account, there are a few things you should know.
"Retirement accounts were created to help you save money over a long period of time to use when you retire. Taking the money out before then can affect how much you'll have later on."
Take a loan...
Retirement accounts were created to help you save money over a long period of time to use when you retire. Taking the money out before then can affect how much you'll have later on. There are basically two ways you can get money out of your employer-sponsored retirement savings plan – take a loan, or withdraw the funds. If your plan allows for tax-free loans, you can access your account – subject to certain conditions – without permanently reducing your account balance. For example, if your balance is $100,000 and you borrow $40,000, you are left with a balance of $60,000. With a loan, you make payments, with interest, to return to your previous balance.
… or make a withdrawal?
On the other hand, if you make a withdrawal, you are not required to return that amount to your plan. It does automatically get taxed, and you could also be charged a 10% federal early withdrawal penalty if you're under the age of 59 ½. But let's take a look at the biggest reason to think long and hard before you decide you absolutely need to take some funds out of your retirement savings.
The long-term effect
Stephen withdrew $50,000 from his retirement plan, which at the time had a balance of $150,000. The withdrawal reduced the balance to $100,000. Stephen decided he needed the money immediately, and that it wouldn't be a problem later. But take a look at the long-term impact.
In this hypothetical example, you can see the impact that withdrawals from your retirement savings can have. At the end of 10 years, Stephen's retirement account – minus the $50,000 withdrawal – grew to $193,888. If he had not taken the withdrawal, the account would have been worth $275,333 – $81,445 more! And after 20 years, the difference is even greater.
Withdrawing money from your retirement account reduces your assets in your portfolio and your potential earnings. It can also have long-term consequences.
- Withdrawing money from your plan could increase the risk of running out of money during retirement.
- Withdrawals are subject to ordinary income tax. Federal restrictions and a tax penalty might apply to early withdrawals.
Taking a loan or making a withdrawal from your retirement account should only be done as an absolute necessity. Talk to your VALIC financial advisor to determine which option is best for you.