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Ask Money Talk – tapping 401(k)

Listener Question: “I saw news reports that more people are tapping into their 401(k) plans because of the economy. What strategies could help them avoid or at least minimize those withdrawals?”

Brian Kilb:

I’ll try to talk clients out of things that don’t make sense fairly quietly and fairly gently.

Taking money out of your 401(k) is one of those where I’m going to yell and scream and shout.

As an offshoot of our weekly podcasts – and to encourage your participation – we regularly feature responses to listeners’ questions.

Here’s an edited transcript of how Brian Kilb, executive vice president of Landaas & Company, addressed a question about raiding money from 401(k) retirement saving plans.

Click here to send us your questions about financial trends and investment strategies.

We don’t see many clients in this boat, but apparently it is something that’s happening more.

It takes a long time to start saving into those plans, and you may get a benefit of an employer match. When you’re under 59½ and you take that money out of a 401(k), not only do you have to pay the income tax – because that money is taxable on top of whatever you earn anyway – but you also have to pay a penalty. So you’re losing in the neighborhood of $2 for every $1 you’re spending from your 401(k).

I don’t know too many worse ways to cause damage to your investment future than by having to dip into your 401(k) savings.

My presumption is in a lot of cases people will only do it as a matter of last resort.

I’m not a big fan of debt, but one of the things you could explore – at least if you have a low debt profile – is you could maybe take a loan out to get you through whatever crisis you’re in. Some 401(k) plans allow you to borrow from the 401(k) plan.

Reinvest that money back into your 401(k) plan when you’re back on your feet. But do anything you can to avoid early withdrawals from your 401(k). The penalties and the income tax are punitive.  

More on early 401(k) withdrawals

10 Reasons Not to Tap Your 401(k), Financial Regulatory Authority

Thinking about raiding your 401(k) plan? Don’t do it, USA Today

Three Alternatives to Raiding Your 401(k), Wall Street Journal

initially posted September 21, 2010

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