by Lauren Rosales-Shepard, Content Writer


Welcome to the second blog post in our series, “Beyond Home Equity: How to Finance Your Next Big Expense.” If you’re looking to finance a big expense, whether it’s a renovation or a large debt consolidation, you might be considering tapping into your home equity–but, you know you should consider the alternatives as well. Over the next several days, tune in to this series of shorter blog posts that delve into some of your options. You can read Part I here. Today: Retirement Accounts and Savings Accounts.

Retirement Account Loans or Withdrawals

As a tool for retirement planning, many of us contribute to a retirement account. A 401(k) is an employer-sponsored plan; however, there are also self-managed retirement accounts called Individual Retirement Accounts (IRAs). Though that sum is meant to grow into a fund that will support you when you’re no longer working full time as a senior, it is possible to make an early withdrawal before you reach that stage of life.

How does a retirement account withdrawal work?

There are multiple different factors that come into play if you’re contemplating an early withdrawal from your retirement.

Age

Before age 59.5: Withdrawals from Traditional IRAs and 401(k)s generally incur a 10% early withdrawal penalty. They are also taxed as income. (There are some exceptions to the 10% penalty, such as medical expenses exceeding a certain percentage of your income).

Age 59.5 and older: Withdrawals are free of the 10% penalty, but income tax still applies for traditional accounts. Note: Roth accounts are tax-free if the account has been open for at least five years.

Traditional vs Roth

Traditional 401(k) or IRA: Contributions are made pre-tax, and withdrawals are therefore taxed as ordinary income.

Roth 401(k) or IRA: Contributions are made post-tax, so qualified withdrawals (after age 59½, and if the account is five years old) are tax-free.

To make a withdrawal, you can log into your account online or otherwise contact your account administrator. Usually, you can opt to receive a lump sum or periodic payments. If you go this route, be sure to plan for the tax impact of the withdrawals, as well as the potential to disrupt your financial goals. It’s a good idea to consult a financial advisor or tax professional to explore your options and understand the long-term effects.

Savings or Emergency Fund

Conventional wisdom recommends that we have at least three to six months’ worth of living expenses tucked away in a savings account in case of an emergency. Obviously, it doesn’t hurt to have more. If you have meticulously saved, and your savings can cover the major expense and still leave you with six months’ worth of living expenses, it might also be possible to dip into that fund.

How does making a withdrawal from savings or an emergency fund work?

You can withdraw money from your savings account by visiting your bank, or making an online transfer. Because this is money you already essentially have, it is not taxed. You also don’t need to pay interest of any kind. However, if you empty your savings in order to cover a major expense, keep in mind that those depleted funds might not be there later if you truly need them.

Continue to Part III.


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