Have you considered tapping your retirement funds earlier than planned?

Retirement savings withdrawals are at record highs in 2023, with 40% of Americans making withdrawals to avoid foreclosure, per the Vanguard group.

While it might be tempting to access those hard-earned funds, think twice before doing so. 

However, you might need to tap your retirement savings prematurely for various reasons, including:

1. Job loss
2. Medical expenses
3. Foreclosure
4. Repaying debt

The good news: As a Gen X saver, you still have ample time to continue your savings efforts before retiring. In this article, we’ll discuss the impact of making early withdrawals from tax-advantaged accounts, like your IRA or 401(k).  

We’ll also touch on the impact on your short- and long-term financial well-being and other alternatives you can consider.  

Want To Make Your Money Work Harder For You In 2024? Check Out These 3 Vital Strategies.

The Financial Impact Of Early Retirement Plan Withdrawals.

You should consider many factors before withdrawing from a tax-advantaged account, such as a 401(k) or traditional IRA. Any withdrawals are taxed because you contribute to these accounts with pre-tax dollars.  

Taxes and Penalties

Early withdrawals come with many financial repercussions, like penalties and taxes.

As an example, let’s say that you withdraw $5,000 from your 401(k) before reaching the age of 59.5, you typically face two main financial consequences:

1. A 10% early withdrawal penalty for a $5,000 withdrawal on the distribution would be $500.
2. The $5,000 is also subject to federal (and possibly state) income taxes as it is taxable. The exact tax rate depends on your total income for the year and your tax bracket. For example, if you are in the 22% federal tax bracket, your tax on the withdrawal would be $1,100 (22% of $5,000). Therefore, the total cost of your withdrawal, after penalties and taxes, could be $1,600 (i.e., $500 penalty + $1,100 tax).

This does not include any potential state taxes, which vary by location.

Compound Interest

Compound interest is often called the “eighth wonder of the world.” Why? Because it can significantly increase your retirement savings over time by earning interest on interest. 

It means that not only do your initial investments earn interest, but the interest earned then continues to earn more interest, creating a snowball effect.

Over time, compound interest accelerates the growth of your savings, which can help you achieve your retirement goals faster. The longer your money is invested, the greater the potential impact of compound interest. 

Suppose you invest $10,000 at an annual interest rate of 5%, compounded annually. Here’s how your investment would grow over time:

• After ten years, your investment would grow to about $16,289
• After 20 years, it would be approximately $26,533
• After 30 years, you would have about $43,219

This example shows that the amount is more than quadrupled over 30 years without any additional contributions, illustrating the powerful effect of compound interest on your savings strategy.

By taking an early withdrawal, you’d miss out on compound interest, which can result in losing significant dollars in the long run.

Long-term Impact 

Making an early withdrawal increases the risk of extending your working years as you struggle to replenish depleted savings. These withdrawals can even force you to take a part-time job in retirement or continue to work indefinitely.

Facing financial insecurity during retirement can take a toll on your mental well-being, leading to increased stress, anxiety, and even depression. The uncertainty of not knowing if you’ll have enough to cover your expenses can weigh heavily on your mind, impacting your overall quality of life.

More Americans are working even during their retirement years. Per financial services firm Empower, over half (58%) of Americans (64% of Baby Boomers and Gen Xers) may be in the job market post-retirement.

An Alternative To Early Withdrawals

Establish An Emergency Fund

Ensure you have at least three to six months of net living expenses in a liquid account like a high-yield savings account, assuming there are no penalties for early withdrawals. If you work in a volatile industry or are self-employed, consider increasing your emergency fund to cover a longer period. You can also use unexpected windfalls like bonuses or tax refunds to boost your emergency fund.

Work with a CERTIFIED FINANCIAL PLANNER™ Professional to create a financial plan

We are a fiduciary fee-only financial advisor in Greeneville, TN, that specializes in assisting Gen X with wealth management services.

In today’s fast-paced world, balancing your financial responsibilities with an active family life can be a real challenge. From the lingering effects of persistent inflation and rising interest rates, it’s easy to feel overwhelmed. 

At Sapiat, we get it—managing money isn’t just about numbers; it’s about easing stress and feeling confident in your financial future.

Life doesn’t pause, making it tough to focus on long-term financial planning amidst today’s urgencies. That’s where the right financial advisor comes in. Yet, the truth is not all advisors are created equal. A 2016 government study revealed that conflicted advice—where advisors benefit from commissions—costs Americans $17 billion annually.

Steer clear of that $17 billion pitfall with a fee-only advisor. As Greene County’s first fee-only firm, Sapiat stands apart. We don’t earn commissions. Our only compensation is your fee, guaranteeing our advice is unbiased. We’re legally bound as fiduciaries to prioritize your financial well-being.

We believe in smart, disciplined strategies over risky bets. Our team employs an evidence-based methodology, focusing on what we can control to help guide your steady progress toward your goals. We also put your financial plan through rigorous stress tests to ensure it stands strong against potential setbacks.

Experience counts, especially with your finances. Unlike larger firms that may prioritize sales over expertise, our seasoned team boasts over two decades of experience, armed with top-tier certifications and specialized training in various aspects of financial management. 

We’re not just advisors but experts who care about your success.

Discover how Sapiat Asset Management can help you organize your finances and plan confidently for the future. It’s time to turn the page on financial stress and start a new chapter in financial freedom.

Click here to start a conversation with us today.