There may come a point when you feel compelled to withdraw money from your IRA ahead of retirement. It may be that you need a few thousand dollars to repair your car, and you don’t have the money in a regular savings account to cover the expense. Or maybe you need some money to fix up your home and are having trouble qualifying for a loan due to a recent hit to your credit score.
The problem with tapping your IRA early is that if you take a withdrawal prior to age 59 1/2, you’ll face a 10% penalty on the sum you remove. So if you take a $5,000 withdrawal, you’re saying goodbye to $500 of that right away.
Now there are some exceptions to this rule. You can get out of paying that penalty if you remove up to $10,000 from an IRA to buy a home for the first time. You can also access IRA funds penalty free to pay for college. Otherwise, expect that 10% hit.
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But actually, losing 10% of your withdrawal to a penalty isn’t the worst financial issue associated with tapping an IRA early. There’s a much bigger financial loss you may be in for.
Your lost investment gains might far exceed your penalty
When you take an early withdrawal from an IRA, you lose some money to a penalty. But worse than that, you lose out on the opportunity to keep your money invested. And that’s where the big issues tend to arise.
Over the past 50 years, the stock market has rewarded investors with an average annual 10% return, accounting for both strong years and poor ones. Over time, the average return in your IRA may be the same.
So let’s say that’s the case and you remove $5,000 from your IRA at age 30 to address an immediate need. You may be at peace with losing $500 of that to a penalty. But you may also be losing out on 10% growth on that sum for three decades. All told, that amounts to over $87,000 in lost retirement income. Compare that to a $500 penalty, and the latter starts to look like pocket change.
Don’t just think about the penalty
You may be willing to accept a 10% early withdrawal penalty if it allows you to access the money you need in your IRA. But remember, the financial hit you’ll take by not investing that money over time could be way worse than what your penalty amounts to.
If you need money for an urgent bill and don’t have the cash in savings, try taking out a loan. And if your credit score isn’t strong enough to qualify for one, see if you can work out an arrangement with a friend or family member where you borrow money and sign an agreement to pay them back. Another option may be to pick up a side hustle to earn the money you need, but this may not work if you truly need money in a pinch (such as if your car won’t start and you need it to get to your job).
Of course, it’s also a good bet to try to build emergency savings so you never have to think about tapping your IRA early for an urgent need. But either way, explore every other option possible before raiding your IRA early. It’s a move that might truly cost you much more than you imagined.
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