As the economic crisis widens, more people are taking early withdrawals from retirement plans. While that could solve immediate problems, draining money from retirement accounts only guarantees you’ll feel the effects of these hard times long after they’ve passed.

According to an AARP survey, 13% of Americans age 45 and older took cash out from 401(k)s or other retirement plans between September 2007 and September 2008 to pay everyday expenses. That’s regrettable, for several reasons. It depletes an account that’s meant to support you after you stop working, and spending the money now means missing years of potential investment gains. In addition, if haven’t passed age 59½, you’ll not only be taxed on the withdrawal but also owe a 10% penalty (unless you meet a few special circumstances). Take, say, a $10,000 distribution, and if you’re in the 28% tax bracket, you’ll pay $2,800 in federal income tax plus a $1,000 early withdrawal penalty. That leaves you just $6,200—before you pay state taxes.

A better option, if you must tap retirement accounts at all, is to borrow from your 401(k) or make a temporary withdrawal from an IRA that you pay back within 60 days. But touching this money should be only a very last resort. Instead, evaluate your spending habits and give up any non necessities. The economy and the markets will inevitably recover, and so will your retirement plan—but only if you haven’t raided it in the meantime.


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