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When a financial emergency hits, you may find yourself scrambling to get your hands on the money you need. You may consider taking money from your 401(k) for emergencies, but experts strongly advise not to.
If you decide to do this, remember that there are some financial penalties for doing so, and you are robbing yourself of a comfortable retirement. A 401(k) should not be used as a safety net in a financial emergency. It should be an account that helps you save for retirement.
Here’s what you can do to prepare for financial emergencies instead.
Can You Withdraw Money From a 401(k) Early?
In most cases, the IRS requires you to be at least 59½ to withdraw money from your 401(k) plan. After all, the funds in that account are designed to support you during your retirement years. If you decide to withdraw money early, prepare to see hefty punishments.
Penalties of a 401(k) Early Withdrawal
401(k) plans were created to help people save for retirement in a tax-advantaged way. To encourage savings, the IRS placed an age requirement on 401(k) withdrawals. Any funds that are withdrawn before 59½ — the minimum age set by the IRS — will be subject to a hefty 10% penalty.
For example, if you take an early 401(k) withdrawal of $50,000, your penalty alone will eat up $5,000 of your distribution.
“In addition, the funds withdrawn will be added to your taxable income and reported on your tax returns,” said Shelli Woodward, a tax analyst with Merchant Maverick.
The amount you’ll pay in taxes on your 401(k) withdrawal depends on your tax bracket. Tax rates in the U.S. range from 10% to 37%. As a result, that same $50,000 distribution could result in an income tax burden of anywhere between $5,000 and $18,500. For folks in the highest tax bracket, nearly half of the $50,000 distribution would be eaten up by taxes and penalties.
Of course, it’s also important to consider the long-term financial penalties of an early 401(k) withdrawal. While these aren’t penalties imposed by the IRS, they are natural consequences of taking funds from your retirement savings.
“Besides the tax implications, you are also eating into your retirement savings,” Woodward said. “This account is intended to help you save for the future and cover expenses when you are no longer working. If you take that out now (or before you retire), …….