Breaking Into Your 401(k) Is An Expensive Way to Raise Cash

If you're looking for money to buy a new car or pay off some bills, your 401(k) plan may seem like a pot of untapped gold.

The temptation to tap your retirement funds often comes when you switch jobs and must decide how to handle your account. But in most cases, breaking into a retirement plan early is a mistake that will just melt away your savings.

Unfortunately, more than 50 percent of all workers "cash out" their retirement accounts when they leave their jobs, according to one survey.

Let's say you're taking a new job and you need $15,000 to buy a new car for commuting. Taking the money from your 401(k) account will hurt you in two ways:

  1. You lose future retirement funds. This is money that could continue to build up while remaining tax-deferred.
  2. You must pay a big tax price. Combined federal and state taxes and penalties can take away as much as 50 cents on every dollar withdrawn early. You might have to withdraw $30,000 to get the $15,000 you need.

This is an extremely expensive way to finance a car. You're better off getting a conventional car loan.

If you desperately need money, look into borrowing against your 401(k) balance, rather than withdrawing the money outright.

A smarter move: Roll the money over into another tax-deferred account, such as an IRA or your new employer's qualified plan.

In any event, it's always a good idea to consult with your financial advisor before making any moves with this money.