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3 Reasons You Shouldn't Raid Your Retirement Account

Jan 18, 2018 3 min read Sheila Olson

Key Takeaways

  • Tapping into retirement accounts before it's time means throwing away a lot of money.
  • Paying for college with retirement funds is a short-term strategy with long-term impact.
  • Paying for a new car or other shiny object with your retirement funds is a big no-no.


Sometimes it's tempting to look at the chunk of cash in your retirement account and consider all the ways it could improve your life today. If you're struggling to come up with a down payment for a home, for example, or need some cash to cover college tuition, it's hard to ignore that nest egg as a source of funds.

While a new home and a college degree are both inherently good things, raiding your retirement account is still a bad idea--because tapping those accounts before it's time means throwing away a lot of money, both directly, in terms of penalties and tax, and indirectly, in lost opportunity and returns you may never recoup.

So before you give in to your retirement-raiding impulses, take a look at these real-money reasons it may be a major mistake.



The cost of homeownership is more than the down payment.

If your retirement account is your only source of down payment funds, you've got more to consider than just the financial consequences of early withdrawal. Most financial professionals strongly caution new homebuyers to look at the hidden costs of homeownership--major repairs, ongoing maintenance, property upgrades--before taking the plunge, especially if they're financing the down payment from a retirement account.

If you've got few cash reserves in your short- and long-term savings, you may not be prepared for the unavoidable expenses that come up when you own a home, and wind up going into debt, further complicating your financial situation over time.

Other consequences are even more worrisome. While the IRS waives the 10% early withdrawal penalty (on IRAs and Roth IRAs) for first-time homebuyers (up to a $10,000 lifetime limit), income tax rules still apply. Depending on your income and how much you withdraw, you could find yourself in a higher tax bracket, costing you thousands of dollars in additional taxes at the end of the year.

Suppose you're 35, currently in the 22% federal tax bracket and 5% for state, and you withdraw $30,000 for a first-time home purchase. Right away, you're losing $8,100 to taxes--but if that $30k puts you into the 24% bracket, you lose an additional $600 on your withdrawal. Since that 10% early withdrawal penalty exception only applies to a $10,000 lifetime limit, you’ll also owe $2,000 for the tax penalty on the balance.

What you lose in compounded returns on your investment, however, is where it really gets painful. Imagine you leave that $30,000 in your retirement account in a fund that tracks the S&P 500, which has historically averaged about 10% a year. That $30,000 would be worth over $500,000 when you turn 65, assuming a historical rate of return.


There are better ways to pay for college.

More Americans are tapping their retirement Opens in new window to fund their children's education than ever before as college costs continue to soar. However, it's a short-term strategy with long-term impact.

The same income tax rules apply as above for any premature withdrawal, and there's a 10% penalty that applies in this scenario if you withdraw from your employer's plan. If you are 55, for example, in the 24% federal tax bracket and 5% state, and withdraw $50,000 for college tuition, assuming you don't jump a bracket, your withdrawal is worth just $30,500 after taxes and penalties--and that $50,000 in an S&P 500 fund for an additional 10 years would be worth nearly $130,000 at retirement. Altogether, you could be looking at a potential hit of $86,500 or more ($80,000 in lost market returns plus $14,500 in taxes and penalties). Although there is an exception to the early withdrawal penalty for withdrawals from IRAs for higher education expenses, that exception does not apply to employer plans.

There's a hidden factor at play, as well: That money counts as income for any financial aid forms you submit in a following year (a withdrawal reflected on your 2017 income tax return will be reflected on your 2019 financial aid forms), potentially affecting your child's grants and loan package.

A tax-advantaged 529 account is generally a wiser choice for college tuition savings over the long haul.


And if you're thinking of using your retirement for a new car, consider this.

If you're considering a premature retirement withdrawal for a new car or other shiny object, take a moment to ponder the ramifications of that transaction.

Cars and most other major consumer purchases are ultimately depreciating assets--they lose value every year you own them. Aside from the penalties and taxes you'll pay, you are swapping an appreciating asset (your retirement savings) for a depreciating one, a double negative no matter how you look at it.

If you're 30 years old, for example, and you withdraw $25,000 for a new car, you're netting just $19,500 after taxes and penalties, assuming you're in the 12% tax bracket with no state income tax.

Imagine you bought a new car for $25,000. Five years of depreciation is estimated at nearly $16,000, bringing your car's value to just $9,000. In addition, over that five years, you've potentially lost $15,000 in market returns in your retirement account on your $25,000.

Add it up, and that new car has cost you over $36,000 in direct costs and lost opportunity in just the first five years alone. That's not even considering the long-term impact--left in your retirement account earning 10% a year in an S&P fund, that $25,000 would be worth over $700,000 if you retired at 65, even if you never contributed another dollar to your account.


What you can do next

Retirement savings should remain just that--money to fund your living expenses after you retire. Don't give in to short-term gratification in exchange for significant long-term consequences.


Please consult your tax and legal advisors regarding your particular circumstances.



Sheila Olson is a Charlotte-based freelance writer specializing in investing, personal finance, entrepreneurship, and retirement planning. She is a regular contributor at Investopedia and writes frequently for the banking and consumer credit industry.


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