You’ve been saving for retirement, maybe you have been getting a company match; you have also either been adding to a Roth IRA account or recently converted your regular IRA into a Roth to get the tax-free withdrawals in retirement. But now we are having a financial meltdown, and you know you can pull the funds from your Roth without the same penalties as in a 401K or traditional IRA. You need the money, and you’re thinking about taking an early 401k withdrawal. But should you withdraw from your 401k or Roth IRA?
When you withdraw from a traditional IRA or a 401(K), you pay taxes and penalties, because the intent of those accounts is to hold the money for retirement. Your contributions have been tax-free, and you will pay taxes when you retire. Withdrawal after 59-1/2 are taxable but are also penalty free. But if you want to withdraw before that time, you will not only pay the taxes you avoided earlier, but a penalty to prevent you from doing so. Now comes the Roth IRA. We’ve set up a 401k rollover into a Roth IRA or opened a new Roth account, to take advantage of the future tax benefits. We contribute to Roth accounts with after-tax dollars, and as a result, in retirement, we can withdraw from our account tax-free also. It’s for this reason, because the growth in the account is also tax-free, that many financial advisors are now recommending that you invest in a Roth for retirement. But there is a downside. Because there are no taxes to be paid, withdrawals, at least of the money you initially deposited, are penalty and tax-free. And when people who don’t save have retirement funds they can pilfer from, they start withdrawing form their future.
The vast majority of Americans have little to no money saved for their retirement over and above what they hope to get from Social Security. this grasshopper vs. ant mentality was possible a few years back when it seemed like prosperity had nowhere to go but up. But today, there is a distinct possibility that we will not see growth – of home values, salaries, or anything that would normally put money in our pockets – for a long time. Even for people who have a twenty-year time horizon before they retire, if the current situation in the United States is anything like the deflation Japan suffered, the likelihood may be that there will be little to no growth in any stock or savings accounts for the next ten years.
So, do you really want to delete what you have now, while you can still earn and save and sell off possessions, and be more broker when you’re 75 years old? With life expectancy increasing, do you really want to be working that waitress job at 69 years old because you took money out of retirement to buy a new $40,000 car when you were 55? Is it harder to ask your child to pay for college today by working their way through, or to expect them to support you alongside their own family in twenty years? We tend to think in short-term time horizons, and today’s needs may be immediate, such as a health care emergency, or job loss. But using retirement funds to support a lifestyle that was built on credit and can no longer be supported unless you use up retirement money is a foolish choice. By taking money out of your Roth IRA withdrawal, or a 401K withdrawal, you are essentially hoping that your kids or the government will be able to support you because you will have nothing left. One is unfair, the other just plain crazy. You really should get better 401k advice to decide what is your financial priority bore you take out the money.
Remember too that if things go horribly wrong, and you do have to file for bankruptcy, your retirement money cannot be touched by your creditors. That money stays put because it has a purpose to fulfill. If you use it all up and then declare bankruptcy anyway, you have truly robbed yourself. It’s much better to tighten your belt as much as you have to right now and leave that retirement money where it is – ten or twenty years down the road.