Please note that the following is meant for informational purposes only and does not qualify as legal or professional advice. If you are seeking professional advice, please speak to one of our CPAs.
Depending on the size of your tax bill, you may now be needing to pull in sources of cash from different accounts after paying off your taxes. You may feel the temptation to withdraw from your 401(k) or Roth IRA in order to do this; it’s often an untouched source of money that people forget about. However, if you are thinking of doing this, be aware that there are severe penalties.
The Financial and Governmental Penalties of Early Withdrawals
For most qualified retirement plans and non-qualified annuity contracts, any withdrawals that happen before you turn 59.5 years old will result in an additional 10 percent penalty on top of any income tax you may owe. For example, if you withdraw $10,000 from your 401(k)—which got deposited without having any tax on it—you would not only owe income tax, you would owe $1,000 on your next tax return. While there are some exceptions, such as following the death of the participant or account owner, a total or permanent disability, as a general rule, the IRS will almost always levy this 10 percent penalty.
The Hidden Penalties of Early Withdrawals
One of the biggest draws of a retirement account is that it can accrue interest over time, meaning that by the time you start taking withdrawals upon your retirement, you will ideally have significantly more money in the account than you actually deposited. However, if you withdraw money beforehand, that advantage completely disappears.
For example, if you had an account balance of $100,000 and left it untouched with returns of 7 percent for ten years, that would result in a final balance of roughly $196,000, or almost double what you had before. Conversely, if you only withdraw $5,000 per year for ten years, you will have a balance of a little over $122,000. While it may be tempting to look at that and say that you still made $22,000, it’s more alarming to realize that compared to not touching it, you missed out on not just the spent $50,000 but an additional $24,000—nearly 1.5 times what you actually withdrew.
If you’re running into a financial situation where you aren’t sure what to do, your best bet is not to withdraw from your retirement accounts. Instead, you can speak to one of McAuley & Crandall’s experienced CPAs for further information at 913-239-9130.