Five Alternatives to Raiding Your Retirement Savings Early

January 26, 2015

Every year thousands of people raid their retirement savings early. It could be to get out of debt, to cover living expenses during a time of unemployment, to deal with a medical crisis, or even help a family member in trouble. While the reasons for doing so may be perfectly noble, it’s best to consider all possible alternatives before doing this.

There are at least four reasons why raiding your retirement savings early is not in your best interests:

  • Income tax liability – If the money is withdrawn before you turn 59 ½, the amount of the distribution will be added to your income, and taxed as ordinary income.
  • Early withdrawal penalty – If income tax liability weren’t bad enough, you’ll be subject to the IRS early withdrawal penalty, equal to 10% of the amount of the distribution.
  • Permanently weakening your retirement – Because of the time value of money, any funds that you withdraw will represent a permanent reduction in your retirement plan. That means you will have less money available when it comes time to retire, and there’s no way to make that up once you do.
  • Selling “the family jewels” – In most households, retirement savings represent the largest percentage of their financial assets. This is long-term money, and if you withdraw it for short-term needs, you will be weakening your family’s overall financial position.

What alternatives do you have to avoid raiding your retirement savings?

1) Sell what ever you don’t need

If you absolutely need a few thousand dollars to cover an emergency expense, consider selling some kind of personal asset instead of raiding your retirement savings.

It could be an extra car, a recreational vehicle, a boat, or even a second home. Selling any of these would be preferable to liquidating retirement savings, as they generally will not create an income tax liability (except perhaps the second home), and certainly not a penalty on top of it

2) Borrow from a family member

Still another way to borrow money rather than liquidating retirement funds, is to get a short-term loan from a family member. If the need for cash is brought on by a true emergency, then a family member would be more likely to step in and help you in your time need.

Once the crisis passes, you can begin working out repayment using one or both of the strategies below.

3) Slash your expenses radically

There are two factors at play here. First, it’s often true that when a person needs to tap retirement savings early, it’s due to some kind of financial imbalance. While the imbalance could be due to temporary factors, such as a job loss (which could become long-term) or high medical bills, it can be due to long-term factors just as well. That might include excess debt levels, high living expenses, or a lack of liquid savings.

If the need for cash is in any way related to long-term financial difficulties, you should seriously consider slashing your expenses radically. That will be the best permanent solution to your money troubles.

Second, lowering your living expenses will also help you to pay off any short-term financing you took to deal with your emergency. Eliminate any recurring expenses that you don’t absolutely need, cut way back on discretionary spending, and even consider how you can reduce your major expenses.

It may be that the house you’re living in is simply too expensive for your income level. In that case you may have to consider downsizing your living space. Or it may be that you have two cars, both of which have payments. You may need to sell one of the cars, and replace it with a very used car that does not require a monthly payment.

Sometimes the only way to get control of your finances is to cut your structural expenses. Not easy to do, granted, but it is a permanent solution to a financial problem, and may help you to repay short term loans taken to deal with the emergency.

4) Borrow from your 401(k)

If you have an employer-sponsored 401(k) plan, you probably have the option to take a loan against it. Under IRS regulations, you can typically borrow as much 50% of the value of the plan, up to $50,000. And you’ll have five years to repay the amount of the loan.

Borrowing money would be preferable to taking distributions because not only would it avoid creating a tax liability, but it would also leave your retirement savings intact.

5) Create an additional income stream

Creating an additional income stream can work well in combination with a short-term loan from your 401(k) plan, a family member, or some other source. The idea is to borrow the money that you need – without taking distributions from your retirement savings – and then to pay it back out of the additional income.

The extra income could be from a part-time job, or a side business. Not only can this be used to cover short-term loans once the crisis passes, but it may also be a way to improve your long-term financial situation, so that you will have less debt and more liquid savings. When the next crisis comes, you’ll be in a better financial position, and won’t need to consider raiding your retirement savings early.

Avoiding early withdrawal of retirement savings is mostly about advanced planning. That means creating extra room in your budget – either by lowering your living expenses or creating more income – so that you won’t have to resort to raiding your retirement savings.

Any one of these strategies will put more money your pocket, without causing an income tax liability that will only add to the financial problems caused by the emergency you need to deal with.


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Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids and can be followed on Twitter at @OutOfYourRut.

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