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How Your 401K Pot of Gold Could Tarnish Fast

Written by Ellen Katz

Want to succeed with saving for the long-term but get what you need today? Make sure what you "need" is really necessary. Is it a "want" or a "need"?melting away savings

 

The money in your 401(k) plan may seem like a pot of untapped gold that can be used for a lavish vacation or a new car. But in most cases, breaking into a retirement plan early is a mistake that will melt your savings like ice cream in the summer heat. 

 
Money Advice:
If you become disabled or qualify for a hardship withdrawal, you can avoid the penalty for early withdrawals.
 
In most cases, you can leave the money in your old employer's plan.
If you desperately need money, see if you can borrow against your 401(k) balance.

If you take the money, not only are you losing future retirement funds, combined federal and state taxes can lop off more than 50 cents on every dollar withdrawn early.


 

Let's say you're single and earning $65,000 a year, which puts you in the 25 percent federal tax bracket. When switching jobs, you decide to take a $10,000 lump sum from your 401(k) to buy a new car. Here's a rundown of what you lose: 

You pay a 10 percent penalty, or $1,000, for taking the money before you reach the age of 59½. 

You owe $2,500 for federal tax at your regular 25 percent rate.

You may owe state taxes, too. If you're lucky to live in a city that imposes income taxes, you could get nabbed there too. So, even before any state taxes, your $10,000 has shrunk to $5,900, an expensive way to finance a car. Your best option: Roll over the money into an IRA and get a conventional car loan.

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