FA Center: We know not to take money early from a tax-deferred retirement account. So why do we do it?

by | May 13, 2023 | Stock Market

Once you earn money, it’s normal to want to spend it. There’s nothing wrong with that, unless it sits in a tax-advantaged account. Most employees who participate in a 401(k) or another defined contribution plan want to build a nest egg. They allocate a portion of every paycheck to it and leave it alone. If their employer matches their contribution, even better.

But when leaving their employer, they might treat their retirement account balance as a ready source of cash. Advisers often urge job switchers to resist that urge; instead, they suggest rolling over the funds into another tax-deferred vehicle so that it continues to grow. Yet many people ignore that advice: About 41% of employees who leave their job cash out of their 401(k). Most of them drain their entire account. The IRS imposes a 10% penalty for withdrawing these funds before age 59 ½. Some savers don’t realize this until it’s too late. Even if they’re aware of the penalty, they may withdraw the cash anyway. That’s especially true for younger individuals who tend to prioritize immediate spending needs over long-term growth. “Sadly, when you’re younger, there can be a lack of long-term thinking,” said Bob Peterson, a financial adviser in Lake Forest, Ill. “It’s easier to just take the money, maybe to pay off credit card or school debt. They may think, ‘I’ll get a check for $10,000 now.’ They don’t realize they could wait and get a check for $100,000 l …

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