November 2008

Should you withdraw funds from your 401(k)?

If you're like many Americans with retirement savings in 401(k) accounts, this has been a painful year. The broad stock market has plummeted, Congress's bailout plan hasn't performed miracles, and many sectors of the economy continue to struggle. Is this a good time to take your retirement savings and run?

The short answer is probably not. Historically speaking, the broad stock market has provided returns that exceed inflation, and despite the ranting of some in the financial press, it's likely to provide such returns again over the long term.

Raiding your 401(k) plan should always be considered a last resort. For one thing, if you're not at least 59½ years old, you'll be hit with a 10% penalty for early withdrawals (except in certain limited cases). Also, money you withdraw will be taxed at your regular tax rate. Say, for example, you're 35 years old and in the 25% tax bracket. If you pull $50,000 from your 401(k) account, your taxes will run a whopping $17,500. And that's not all. Even if your 401(k) account earns a measly annual return of 5% over the next 30 years, your $50,000 could grow to over $215,000. So a $50,000 withdrawal taken and spent today could cost you $232,500 in taxes and lost opportunity. A heavy price to pay.

Bottom line: If at all possible, find other ways to pay your bills. Here are three suggestions.

Cut back on expenses. Yes, it may be painful to forego that double latte and deli sandwich at lunchtime. But if you're struggling to pay the mortgage, it may make sense to redouble your efforts at reducing expenses.

Take a second job. Perhaps only one spouse is bringing home a paycheck. In the short term, a second income may provide enough cash to forestall foreclosure or keep the creditors at bay.

Contribute less. It's always wise to contribute up to any matching funds your company provides for retirement. For a time, however, you might consider reducing contributions that exceed the matching amount.

Although some companies allow 401(k) loans, that option should be considered a last resort as well. Again, money that's not in the account won't grow. Also, lose your job and you'll have to repay the outstanding loan balance or face withdrawal penalties.

Now is the time to take a deep breath, retreat a little from the hubbub, and calmly take inventory.

If you'd like assistance with financial issues, give us a call.