Should You Make an Early 401k Withdrawal?

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Should You Make an Early 401K Withdrawal?

Reasons It Could Make Sense to Make an Early Withdrawal From Your 401K

It's hard to give advice on whether to make an early 401k withdrawal, as we don't know your specific circumstances. Normally, we'd advise against it, but there are circumstances where it makes sense. And if you decid to do it, we can help you calculate 401K early withdrawal penalties.

401K Early Withdrawal Penalties

Making an early 401k withdrawal should be a last resort. We'd never recommend cashing out your 401k because the market is down, or because you want to buy a new car. However, there are some legitimate reasons to cash out. We'll list a few below and an example of how the early 401k withdrawal penalties are calculated.

Reasons It May Make Sense to Make an Early 401k Withdrawal

  • You're leaving your employer and only have a few hundred dollars in your account.
  • An emergency comes up and you have no other way of paying for it. If it is a medical emergency, your retirement accounts are protected and should not be used for payment.
  • You are young enough to still save for retirement and you absolutely need the money to live

Reasons That Don't Make Sense to Make an Early Withdrawal

  • You're close to bankruptcy (retirement assets are protected by bankruptcy so think twice before withdrawing them for this reason)
  • To buy anything that you don't absolutely need
  • To pay down your credit card debt

How to Calculate 401K Early Withdrawal Penalties

You will be taxed on any withdrawal you make at your marginal income tax rate. You will also have to pay an early withdrawal penalty of 10% of your withdrawal. For example, if you made $50,000 last year and withdrew $40,000 from your 401k you would pay the following: Income taxes on $40,000 at the federal 25% tax rate plus state taxes (we'll assume 5%). That would mean an extra $12,000 in taxes. In addition you would pay $4,000 in 401k early withdrawal penalties. So in the end, you'll pay about $16,000 in taxes on a $40,000 withdrawal. That is why you should only make an early withdrawal for dire circumstances.

 

See Also:  Other 401k Articles