Why Suze Orman Says Tapping Retirement Savings Early to Cover Emergencies Is a Bad Move
KEY POINTS
- If you need money in a pinch, you may be inclined to tap your IRA or 401(k).
- Doing so could result in a world of unwanted consequences.
- You don't want to face a tax penalty or be left without enough money to live on in retirement.
It's a decision that could cost you big time.
Socking money away in an IRA or 401(k) plan for retirement is an unquestionably good idea. Once you stop working and earning a paycheck, you should expect to need more than just Social Security to make ends meet. And unless you have a pension or another obvious retirement income source (many workers today don't), you'll need savings to supplement those benefits.
Meanwhile, if you have money in an IRA or 401(k), you might assume that you don't have to worry so much about building up an emergency fund. After all, if you have thousands of dollars sitting in a retirement plan, you can always take a withdrawal should an immediate need for cash arise, right?
Wrong. While you might get away with raiding your IRA or 401(k) early, doing so could result in a world of unfavorable consequences, insists financial expert Suze Orman. And so you're better off leaving your retirement funds alone and building up a savings account balance instead.
Early retirement plan withdrawals are bad news
The problem with tapping an IRA or 401(k) ahead of retirement is twofold. First, if you take a withdrawal from one of these plans before age 59 ½, you'll face a 10% penalty for removing those funds early. So if you take a $10,000 withdrawal at age 40 to cover some medical bills, you'll lose $1,000 off the bat. Plus, if you have a traditional IRA or 401(k), you'll also pay taxes on your withdrawal (though to be fair, you'd pay those during retirement, too).
Why such a steep penalty? The IRS offers tax breaks to workers who contribute to an IRA or 401(k). Specifically, the money you put into a traditional IRA or 401(k) goes in tax-free so that if you contribute $3,000 one year, that's $3,000 of earnings the IRS won't tax you on.
But the IRS wants IRA and 401(k) participants to reserve that money for retirement. And so it doesn't take kindly to early withdrawals -- clearly.
Costly penalties aren't the only reason to avoid an early IRA or 401(k) withdrawal. The other issue is that the more money you remove from one of these accounts earlier in life, the less money you'll have later in life. And that means you'll risk a financial shortfall at a time when working even part time may not be an option due to health or mobility issues.
Leave your retirement savings alone
If you've managed to amass a nice retirement nest egg, you should congratulate yourself for doing so. But that doesn't mean you're off the hook when it comes to building an emergency fund.
You need money in a regular savings account to cover things like sudden home repairs, car-related issues, and medical bills -- or to cover your expenses in the event of an unexpected layoff. And the sooner you build yourself that near-term safety net, the more confident you can be in your finances as a whole.
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