Life will throw curveballs at you when least expected. As you’re faced with emergencies, your 401(k) might seem like a quick fix or even your only option. It is necessary to consider the downsides before you act. I’ll explain why tapping into your retirement savings early might not be the wisest move and suggests other ways to handle emergencies without jeopardizing your retirement.

1. Penalties for Early Withdrawal

If you are under 59½, withdrawing from your 401(k) comes with a steep price. You’ll face a 10% early withdrawal penalty on top of regular taxes. This will significantly shrink the amount you receive from the distribution.

Some 401(k) plans allow for hardship withdrawals, which are not loans, and permanently reduce the value of the participant’s portfolio. If an individual is permitted to take the hardship withdrawal, the withdrawal amount is added to taxable income the year it is distributed (unless the funds were post-tax contributions).

2. Shrinking Your Retirement Funds

Remember, your 401(k) is your safety net for retirement. Taking money out now means you’ll have less later. The power of compounding interest can make your savings grow over time. By withdrawing early, you miss out on potential growth.

3. Disrupting Dollar-Cost Averaging

Your 401(k) contributions happen consistently, which is great for a strategy called dollar-cost averaging. It means you buy more shares when prices are low and fewer when they’re high. But if you pull out money during a market dip, you miss the chance to buy low, potentially derailing this strategy.

4. Higher Taxes the Year of

While you put pre-tax money into your 401(k), withdrawals are taxed as regular income. Pulling out a lot at once could push you into a higher tax bracket, leading to a bigger tax bill for the year.

5. Explore Other Options First

Before raiding your 401(k), check if there are better ways to handle emergencies. Having an emergency savings account fully funded, getting a low-interest loan, or using a home equity line of credit are typically considered safer alternatives to protect your retirement savings.

Are you thinking of taking a withdrawal from your 401(k) plan? Schedule a meeting with MFG so we can discuss your options!