After a ten-year boom, it's layoff time again in America. And your own retirement account can look like a good place to find money to pay the bills until you find a new employer.
But think carefully before you take the cash. If you find yourself unemployed, you can either keep your retirement money in your former employer's 401 (k) program-an option if you have more than $5,000 in the account-or roll it over to an IRA.
The money you take out of your retirement plan before you retire costs you in two ways: in fees and taxes you won't enjoy paying now; and in profits you won't enjoy spending later.
If you tap your 401(k) for $10,000 to tide you over until you're employed again, you will pay an immediate penalty of 10 percent, or $1,000, if you're under the age of 55. You'll also owe income tax on the money. At 28 percent, that's another $2,800 that goes to Uncle Sam. Before you even spend a dime, your withdrawal drops by 38 percent, losing nearly half its value and costing you far more than it would if you borrowed it as an advance on your credit card. If your tax bracket is higher, you lose even more.
But that's not the worst of it. The impact of tax-deferred compounding on money that is left to grow is probably much higher than you think. If you are 40-years old when you withdraw that $10,000, you'll have $68,484 less at age 65 than you would have had if you'd left the money growing at 8 percent in a retirement account. If your investments gained 10 percent, your loss grows to $108,346 by the time you're 65. And if you left that money in the account until age 70 1/2-the age at which mandatory withdrawals kick in-you could be forfeiting upwards of $174,000.
The same compounding magic that makes retirement accounts grow so handsomely turns and bites those who take the money and run. In other words, investors should tap their retirement accounts for emergency cash "only if they have no other place where they can get money," says Dallas Salisbury, president of Employee Benefit Research Institute in Washington D.C.
What are some of those other ways of dealing with your cash crunch?
* Reduce expenses. It's a start. Even if you're still in the red, you'll need less help.
* Tap your home equity. About two-thirds of Americans own homes, Salisbury says, and this can be a good source of temporary cash. A home equity loan's interest is often tax deductible, which makes a loan far more attractive than retirement money.
* Negotiate with creditors to defer or reduce payments. Some debts, such as student loans, are eligible for unemployment deferment. Interest still accrues, but you don't make payments until you're employed again. Your mortgage holder may be willing to create a payment schedule that fits your temporary circumstances. Family Means Consumer Credit Counseling Service (800-388-2227; www.nfcc.org) can negotiate with creditors to reduce interest rates and eliminate late charges. They'll also set up a payment schedule that suits your budget.
*Find out if you can borrow from your 401(k) instead of withdrawing the money. Few 401 (k) plans allow loans to participants who are not current company employees because there is no way to enforce repayment, which is usually done through payroll deduction. But your plan could be an exception. It's worth asking. If you secure a loan from your 401 (k) program, you pay yourself back with interest, although you forfeit any gains your money might have made in your account while the loan is outstanding.
Be careful, though. If you think you might outwit your employer and take out a 401 (k) loan on the rumor of layoffs, while you're still employed, your employer is likely to demand full, immediate repayment if you quit or are let go. And if you can't repay the loan, the outstanding balance will be treated as a withdrawal, subject to immediate tax and penalty.
But here's some good news: If you take money from your retirement plan and find yourself back on the job within 60 days, you can put it back into your account with no penalty or taxes due. (You'll have to file for the tax refund at tax time.) If your circumstances change, don't miss out on this opportunity to get yourself back on track for a comfortable retirement. Then, take a lesson from your last experience. Vow to put away something for future emergencies. And think of your retirement savings as money under lock and key for your golden years.
Alan S. Friedlander owns a financial services practice serving Chicago and the suburbs. He offers retirement, investment, and business planning advice. He is a Registered Representative of Commonwealth Financial Network - a member firm of the NASD/SIPC. For your free retirement planning review, or for questions, Mr. Friedlander can be reached at 847/296-9595 and at alfriedlander@yahoo.com.