Before taking any tax or penalties into consideration, just the fact money intended to fund retirement will be reduced by a withdrawal should be enough to cause most individuals to reconsider and find another method to pay those bills. Any money withdrawn will no longer have the ability to earn money thus not only is the initial money lost but any potential for that money to earn is lost once it is withdrawn.
If an individual contemplating withdrawing his or her retirement funds is under 59 ½ typically there is an early withdrawal penalty of 10% which must be paid either at the time of withdrawal or at income tax time. Additionally, any money withdrawn is subject to the individual’s federal, state, and possibly local income tax rate plus the amount withdrawn might be enough to push the taxpayer into the next federal tax bracket. Even what might be considered a moderate withdrawal amount can be rapidly depleted by taxes and penalties.
Using a scenario of withdrawing $10,000, the taxpayer will pay $1,000 for the 10% early withdrawal penalty, then if he or she is in the 25% bracket another $2,500 for federal income tax. At this point the $10,000 withdrawal is down to $6,500 and that’s before state and any local taxes!! If the state rate is a moderate 5% the taxpayer will pay $500 and is left with $6,000. In areas with a 1% school income tax rate, the money needed to pay this school income tax will cost the taxpayer another $100. Therefore, paying those bills with the remaining $5,900 by withdrawing $10,000 will cost the taxpayer $4,100 or 41%!!! Ouch!
Suddenly, a part-time job to pay those bills is looking better and better. But if a part time job is not possible, there are other options which should be investigated before tapping retirement money. This would be an excellent time to check with your financial advisor for suggestions. Any scenario should be more appealing knowing that withdrawing retirement money can cost so much in the long run.
Submitted by Kathryn Shrader, Postema Accounting Solutions
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