NEED EXTRA MONEY?: Do Not Do This!

By on Aug 21, 2010 in Investing, Saving | 19 comments

Do not withdraw Funds from your Retirement Savings

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“Develop success from failures. Discouragement and failure are two of the surest stepping stones to success.” Dale Carnegie

World renowned for his inspirational teachings, many a successful individual  has started out on a foundation of Carnegie’s lessons.

MAIN TOPIC: Read this if you are Desperate for Cash

Financial problems are a reality today. We are not out of the economic woods with unemployment hovering around 9% or worse in some areas, and many homes worth less than several years ago. Foreclosures are rampant.

 If you are on the brink of a financial disaster, and have a 401(K) or IRA from an employer, you may be tempted to withdraw those funds. In fact, last spring when I was volunteering for the IRS, preparing tax returns, I came across more than 1 individual who cashed out their retirement funds.

There are HARDSHIP standards which let you cash out your retirement account before the mandatory retirement age. According to the 401K Help Center:

“The following items are considered by the IRS as acceptable reasons for a hardship withdrawal:

  1. Un-reimbursed medical expenses for you, your spouse, or dependents.
  2. Purchase of an employee’s principal residence.
  3. Payment of college tuition and related educational costs such as room and board for the next 12 months for you, your spouse, dependents, or children who are no longer dependents.
  4. Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence.
  5. For funeral expenses.
  6. Certain expenses for the repair of damage to the employee’s principal residence.”

Here is why you DO NOT WANT TO WITHDRAW FROM YOUR 401(k) OR IRA:

Hardship withdrawals are subject to income tax and, if you are not at least 59½ years of age, the 10% withdrawal penalty. You do not have to pay the withdrawal amount back.

HERE IS HOW MUCH YOU LOSE:

 Withdraw $2,000.00 and take away 10%, that leaves $1,800.00. If you are in the 28% tax bracket, subtract another $560.00. Now you are down to $1,240. And that is BEFORE state and local taxes.

In summary, withdraw $2,000.00 and walk away with less than $1,240.00. Does that sound like a good deal to you?

If you need more motivation, consider this, when you take out cash from your retirement account, not only are you paying fees and taxes, you are losing money that is VERY HARD TO REPLACE. Left in place, you are providing for your future and giving your funds a chance to grow TAX FREE

In fact take that $2,000. Leave it in a stock index mutual fund for 20 years. With an average 9% return (long term historical return from stocks), in 20 years your original $2,000.00 is worth $11,208.82. Compare that with the $1,240.00 value NOW.

PRACTICAL APPLICATION: TAKE EXTREME MEASURES

Before even THINKING ABOUT withdrawing funds from your retirement account, do everything you possibly can to CUT EXPENSES DRASTICALLY. Leave no alternative unexplored.

My blogging colleague Jacob, at Early Retirement Extreme is an expert at cutting down expenses to the bare minimum. You would be surprised how little one needs to live on!

Before you TAKE MONEY OUT OF YOUR RETIREMENT ACCOUNT, follow these steps:

Reduce auto costs, get rid of one car or sell expensive car and buy CHEAP one.

Sell your home, move into an apartment.

Sell your stuff on eBay and Craig’s list.

Do all cooking from SCRATCH; no prepared foods. Cut food bill way down. Substitute beans & rice for meat!

Enlist your kids and get their ideas on cost cutting. No extravagances for them.

For an indulgence, bake a cake, take a walk, have a picnic!

Call all service providers and insurers to negotiate lower rates. Cut out cable, read instead. Cut out all subscriptions.

Read the list of blogs at the end of this article for more great cost cutting resources.

Don’t forget considering ALL ALTERNATIVES to make extra money!

Do your best to withstand the current financial hardship with PERSISTENCE, RESILIENCE, CREATIVITY, & PATIENCE. If you take action, your situation will improve. Borrowing from your future is a step to avoid AT ALL COSTS!

ACTION STEPS:

Get a notebook and label it: “(your name) Personal Finance” and keep it by the computer. Use it to keep all of your personal finance goals, thoughts, activities, and plans.

Make a list RIGHT NOW of every way possible to cut expenses.

Make a second list of every way you can earn extra income. If you are unemployed, be sure to check out TIP #2 from this article. Consider a 2nd job or freelance/entrepreneurial activities.

Write in with your cost-cutting stories and any related questions. I am happy to help!

SAVING & COST CUTTING ARTICLES FROM WELL REGARDED PERSONAL FINANCE BLOGGERS:

Redeeming Riches

Consumerism Commentary

Single Guy Money

Consumerism Commentary

One Money Design

Wealth Pilgrim

Early Retirement Extreme

Not Made of Money

Sweating the Big Stuff

Deliver Away Debt

Little House in the Valley (get her free eBook on credit)

Budgeting the Fun Stuff

    19 Comments

  1. This is the option of last resort in my book. I’d do it only if there were no other alternative.

    The Biz of Life

    August 21, 2010

  2. I didn’t realize that a hardship exemption still had a penalty tax. Some favor! I think the problem that a lot of people are having is they CANNOT sell their house, at least not for anything near what owe on it. After losing a job and not being able to find one, they have spent their emergency fund. Then it’s a choice between foreclosure or liquidating retirement funds, and very few people will voluntarily choose the former.

    Jennifer Barry

    August 21, 2010

  3. Many people look at their retirement savings as if it’s just a regular savings account. Your example does much to show the folly of this thinking. I also really like your list of things to do before getting to this step!

    Khaleef @ KNS Financial

    August 21, 2010

  4. @Biz & Jennifer-Agreed. Obviously, sometimes there is no althernative. I certainly do not want to minimize financial difficulties, but to present alternatives.

    @Kaleef-Absolutely,retirement savings must be treated with the utmost of care. They receive unbelievable tax advantages as well as corporate matching funds(frequently).
    Thank you all for continuing the conversation!

    Barb

    August 21, 2010

  5. The penalties are quite steep indeed, but what if that’s really the last straw? Gotta go for it right?

    The Yakezie

    August 21, 2010

  6. @ Yakezie, YES, if it’s really the last straw…. you do what you must! Just don’t take the decision to withdraw lightly or ignore what you are giving up. Thanks for the visit!

    Barb

    August 21, 2010

  7. Wow Barb, interesting to see the figures and see how screwed you get if you cash out!

    Forest

    August 22, 2010

  8. Please exchange “Lose” for “Loose” in the post.

    Holly

    August 22, 2010

  9. @Forest, It’s an awful deal to cash out unless THERE IS NO OTHER ALTERNATIVE.
    @Holly, Glad you are reading and awake! :)
    I appreciate the feedback.

    Barb

    August 22, 2010

  10. Its sad that some people are in a situation that they are up against the wall and so desperate. I see the boarded up homes in my area and think of the lives destroyed.

    50plusfinance

    August 23, 2010

  11. Hi 50, I couldn’t agree more, actually, those are just the folks I would like to reach. Basic financial literacy can go a long way towards helping avoid those catastrophic mistakes.

    Barb

    August 23, 2010

  12. Barb,

    Congratulations on the speaking post.

    I’ve seen many people take out money from their 401Ks even when they don’t need it. You can’t force a horse to drink, unfortunately.

    Since I manage 401Ks, we see at least 1 person a week doing this. Why? because of fear and frankly, people don’t believe what you tell them even when you give them IRS paperwork.

    They’re afraid they’ll lose money in the market so they take it out of the 401K instead of putting it into a stable value account.

    95% of the participants withdraw based on the recommendation of a relative or friend despite us educating them. We always ask them to wait 24 hrs and think about it and they always withdraw after that waiting period.

    Kim

    August 23, 2010

  13. Hi Kim, Your opinion really adds some depth to this topic. The ones’ you are describing don’t need the money? You have got to be kidding me. That is just insane…. They need to look at the finance research or at least get some data. Those individuals could even choose a “guaranteed” type product with characteristics of a CD.
    I am surprised this practice is so prevalent. Thank you for your insight.

    Barb

    August 23, 2010

  14. I would like to say once again – “there is no shortcut to success”. What I mean is that if you need money then work few extra hours dude..

    Canadianmortgageadvisor

    August 23, 2010

  15. Woah… completely agree with you. I would consider withdrawing retirement savings as an absolute last resort…

    Kevin@InvestItWisely

    August 24, 2010

  16. Barbara,

    Money is emotional. I’ve learned over the years that no amount of facts will convince people when they are emotional. So, I chose to reach them a different way via the blog. It will take time (years and years) but if we can help a few change their perspective on life then it has been worth it.

    I’ve seen so many bad financial decisions by people that I no longer stress about it. I just give them a choice, if you work with me then stick with the plan or find someone else who match your needs.

    Until people are ready to commit to taking care of themselves financially, it just won’t happen. Similar to an addict.

    Kim

    August 24, 2010

  17. The only circumstance I where I could justify withdrawing/borrowing money from a 401K or retirement is to cover a major medical problem.

    The Biz of Life

    August 24, 2010

  18. @Canadian-Well put!
    @ Kevin- That’s how I see it too!
    @Kim- Ever heard this one: “you can lead a horse to water but you can’t make him drink.” Your attitude is on the money.
    @ Biz- That’s having a clearly defined parameter!
    You have all made this article better by your participation :)

    Barb Friedberg

    August 24, 2010

  19. I am glad to be a visitor of this arrant website ! , thankyou for this rare information! .

    Margery Doyel

    April 25, 2011

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  1. Weekly Roundup for 8.15.10 – Forced Volunteering Edition - [...] Friedberg @ Barbara Friedberg Personal Finance gives great advice in “Need extra money? Do not do this!”. Many people …

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