Is It Ever Okay to Tap Your Retirement Account?


Quick! Think of all the jobs you’ve had in your life. Takes a little while to tabulate, doesn’t it?

Based on recent data from the Bureau of Labor Statistics, you’re likely to have about seven gigs under your belt by the time you’re 28. Keep going, and you might work at more than a dozen places over your lifetime.

Along with all of the new-hire paperwork, orientations and other to-dos that accompany settling into a new company, don’t forget to squeeze in some time for retirement planning—especially if you were contributing to a 401(k) plan at your old employer. That money you saved up is important. After all, you’ll be living off it someday.

Unfortunately, this is the exact point when 20 percent of Americans (and 16 percent of those under the age of 35) make the big mistake of cashing out their 401(k)s completely, according to Fidelity statistics. This move hurts you in three ways: When you’re younger than 59½ years old, you’ll have to cough up a 10-percent penalty for tapping the funds early, pay regular income taxes and be denied a boatload of money to enjoy in the future.

Case in point: Fidelity figures a hypothetical 30 year old who leaves his $16,000 balance invested instead of withdrawing it could have $81,500 by the time he’s 67, given a very modest 4.5 percent annual return—which means he’s likely to have even more if the market performs better.

So what should you do with your 401(k) when leaving a job? We’re glad you asked.

An easy option is to stay put in your former employer’s retirement plan, provided your balance exceeds $5,000. (If it’s less, your employer may elect to cash out your account or “force a transfer” to an Individual Retirement Account of their choosing, if you don’t leave instructions for the money.) You won’t be able to make new contributions, but you can reallocate existing money among the investment options.

Better alternatives: You can consolidate your money into your new employer’s 401(k), if allowed, or roll it over to your own IRA, which is what Chris Carosa, a Certified Trust and Financial Advisor and author of “Hey! What’s My Number? How to Improve the Odds You Will Retire in Comfort,” recommends.

“While large companies can negotiate lower fees for their retirement plans in ways you cannot for your IRA, all corporate retirement plans must pay additional administrative fees that you do not,” he says. “In addition, you’ll usually have much more flexibility with your own IRA, in terms of both investments and access to the funds. The one drawback is you no longer have a plan sponsor with the fiduciary liability to oversee your assets. This can be mitigated—at a cost—by hiring a professional fiduciary to serve the same purpose.”

Okay, so no cashing out after switching jobs. But how about in an emergency situation—is it okay to tap a 401(k) then? Probably not, even if you intend to pay it back.

Although most 401(k) providers allow you to take out a loan, there are strict guidelines to comply with (plus, you’re still missing out on future returns while the money’s out of the account). For example, you can only take out half the fund’s vested value up to $50,000, and you must typically repay it within five years, unless it’s for a primary home purchase. If you don’t follow the repayment schedule, the loan is considered a distribution and is subject to the 10-percent penalty and tax hit. And should you leave or lose your job while you have an outstanding loan, you could have just 60 days to come up with the entire loan balance in order to avoid tax consequences.

If you need money in a hurry—to cover a repair, medical bill or other unexpected event—pulling it from your regular savings or checking account is a far better choice. Even using credit would be preferrable. While high-interest debt should be avoided at all costs, a 0-percent-interest offer could be useful in a pinch, so long as you pay it off before the deal expires.

There are, however, a few unique instances when you might (very carefully) consider accessing other accounts earmarked for retirement.

Here’s one: “A Roth IRA can be useful as an emergency fund since you can withdraw up to the amount of your contributions with no taxes or penalties,” says Ken Tumin, co-founder of Just be sure not to dip into your returns, as that will trigger penalties.

You can also take withdrawals from your traditional IRA for the purchase of a first home or to pay for qualified higher education expenses, among other specific exceptions to the 10-percent penalty rule. But Carosa suggests discussing this move with a tax pro before pulling the trigger, as IRS rules and requirements can, and do, change frequently. And remember that if you take money out of an investment account, you’re not just missing out on that money you withdraw in the future, you’re missing out on the potential returns it could have generated as well.