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March 21, 2023 | Article | 4 min | Personal Insights

Tapping Your Retirement Account for Other Financial Needs Can Have Costly Consequences

According to a December 13, 2022, article in The New York Times, hardship withdrawals from workplace retirement accounts are rising — “another sign, along with rising credit card debt, that many Americans have been feeling financial pain from inflation.”

At some point, most people find themselves in a situation where they need access to cash quickly. If that happens to you, you may think about taking money out of your retirement plan account through either a loan or distribution. While those are both possible options, you need to understand the impact of this action on your long-term goals.

Hardship Withdrawals

Hardship withdrawals can be taken for “immediate and heavy” financial need, according to the Internal Revenue Service. But while a hardship withdrawal may solve a short-term issue, it may have a costly impact. Consider the following chart to see the financial implications before you remove funds from your account. If you're under age 59½, you may get hit with both ordinary income taxes and an additional 10% federal income tax penalty.*

Amount of withdrawal: $40,000
Ordinary income taxes: ($9,600)
Early withdrawal penalty tax: ($4,000)

Leaves you with just: $26,400

Assumes the account holder is under age 59½ (and no exception to the 10% additional tax applies) and has a 24% effective federal income tax rate. Additional state and local income taxes may be levied (if applicable).

* There are a few exceptions to the 10% penalty, including a birth or adoption, terminal illness, and a qualified disaster. Check with a tax professional to confirm which expenses are exempt from the 10% early-withdrawal penalty.

Plan Loans

When you take out a plan loan, there are no income tax or early-withdrawal penalty consequences. However, you generally have up to five years to repay any loan from your retirement plan account. Leaving your job (or losing it) before the loans are repaid may mean you have to pay the money back in full right away. If you don’t, the amount that still needs to be repaid may be considered a distribution and subject to federal and state income taxes (if applicable), as well as the additional 10% federal income tax penalty if you are under age 59½ (unless an exception applies).

Missing Out on Potential Growth Opportunities

As much as you may need the money now, taking a distribution or borrowing from your retirement account undermines the potential for the funds to grow through tax-deferred compounding — on both the money you have invested as well as any growth of that money’s earnings. This could make it more difficult for you to reach your retirement goals.

If you’re thinking about taking a distribution or loan from your retirement plan account, consider consulting with a financial advisor (your plan’s advisor may be able to help).

Heartland Retirement Plan Services are offered through Dubuque Bank and Trust Company. The information provided herein is general in nature and is not intended to be nor should be construed as specific investment, legal or tax advice. The factual information has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. Heartland Retirement Plan Services makes no warranties with regard to the information or results obtained by its use and disclaims any liability arising out of your use of, or reliance on, it. Products offered through Heartland Retirement Plan Services are not FDIC insured, are not bank guaranteed and may lose value, unless otherwise noted.