Is It Ever OK to Make Early Withdrawals from your Retirement Assets?

Economists have warned that it could take much longer for U.S. employment to recover than the economy as a whole, which is actually not unusual. Employment has taken two or more years to return to peak levels following six of the past 11 recessions.1
When workers are laid off or transitioning to new ventures, they face a choice about what to do with the assets they have accumulated in employer-sponsored retirement plans. Unfortunately, more than one-third of workers aged 50 to 59 opt to cash out.2
There are few ways to sabotage your retirement goals more effectively than tapping your retirement assets before you reach age 59½. Here’s why.
Taxes and penalties. Contributions and investment earnings withdrawn from a traditional IRA or an employer-sponsored retirement plan are subject to ordinary income taxes, regardless of the account owner’s age (except when withdrawing nondeductible contributions or from a Roth IRA). Investors younger than 59½ can expect to pay a federal income tax penalty equal to 10% of the withdrawal, in addition to income taxes.
Opportunity cost. Consider a 50-year-old who has been contributing $1,000 per month to an employer plan that earns a hypothetical 6% average annual return (see chart). After he is laid off, he withdraws $25,000 to help supplement his unemployment benefits during his job search. If he is able to return to work and resume annual contributions the following year, his retirement balance at age 65 would be about $88,000 lower than if he hadn’t tapped the account and postponed contributions. His retirement savings would be reduced by more than $3.50 for every $1 he withdrew, not including the taxes and penalties he paid on the $25,000 withdrawal.
This material was written and prepared by Emerald. © 2010 Emerald