Are you hesitating to invest in an employer-sponsored retirement plan because you want access to your money if you need it? While retirement plan savings should be preserved for retirement, you might be able to take out your money early for other needs. If your plan allows loans or hardship withdrawals, it’s important to know you can use your savings in an emergency.
If you take a loan from your retirement plan, you’ll withdraw money from your account to use now. You’ll then pay back the loan in installments. A portion of the loan amount will be automatically deducted from each paycheck and put back into your account.
You’ll have to pay interest on the loan, but that’s not as bad as it sounds. The interest actually goes back into your account. In other words, you’re paying the interest to yourself.
Your plan may allow you to take hardship withdrawals for large and immediate financial needs, such as expenses for education, housing, medical care, or funerals.
The short-term cost of a hardship withdrawal is that you’ll pay applicable income taxes and early withdrawal penalties. For example, if you needed $10,000 and opted to have taxes of 25% withheld, you’d need to withdraw $13,333. You might also have to pay an additional 10% for an early withdrawal penalty at tax time.
The long-term cost of a hardship withdrawal could be even greater. Unlike loans, hardship withdrawals cannot be paid back. The money withdrawn leaves your account and loses its tax-advantaged growth potential. A withdrawal could leave you with significantly less at retirement unless you increase your contributions. Even then, it may be difficult to make up for lost time and the benefit of compounding. The rules also prevent you from contributing to your plan for six months after a withdrawal.
Taking a loan or hardship withdrawal from your retirement plan account to meet short-term needs can end up costing you more than you expected in the long run. That’s why you may want to use your retirement account only as a last resort.
Ask your human resources department whether the plan allows you to tap into your savings early.
Your financial professional can help you explore all of your options. Together, you’ll be able to make informed decisions.
Mary plans to retire in 30 years and has $50,000 in her retirement account. She contributes $200 a month.
Mary takes a $10,000 loan and pays 6% annual interest. Her monthly loan payment is $193.33 over 5 years. To keep her take-home pay about the same, Mary stops making contributions while repaying the loan. She starts contributing again after the loan is repaid.
How much would this $10,000 loan cost in the long run? Compare Mary’s account value at retirement with and without the loan:
A $10,000 loan would leave Mary with about $113,000 less in her retirement account after 30 years if her contribution level and investment returns remain unchanged.
Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.
Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.
This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.