The Cost of Dipping Into Your Retirement

By Mary Hunt

August 29, 2016 5 min read

More people than ever are taking loans from their retirement accounts, simply because they can. Here's the problem: seeing your retirement account as a savings account — or worse, a personal ATM machine. It's so ridiculous, I cannot even tell you. Sure, it's your money, but it's not money for now. It's for later. It should be out of your reach, so you need to get it out of your mind.

The beauty of an IRS-approved retirement account is that you get to save pre-tax dollars. It's no secret that the amount on your paycheck is not the full amount you earned. In fact, many elected officials are trying to shrink our earnings even more by increasing taxes. You know what I mean if you live in California — one of the most heavily taxed states in the country, with a governor who is threatening to, once again, increase sales tax, personal income tax and small business tax. (Did I mention my husband and I left California for this very reason?) But I digress...

A retirement account allows you to put aside some of your earnings before they are taxed. For example, if you want to take money home, you have to earn about $1.00 to see 75 cents in your paycheck. But if you put that dollar into a retirement account instead, you get to deposit the full dollar. You essentially get to invest the 25 cents that belong to the government. It's not a gift — you will have to pay that 25 cents to the government eventually. But until then, you get to earn growth off of those 25 cents! Get it? And that money is all locked up, so it is safe from YOU. That's the beauty of a retirement account.

Now, if you stick your hands in there and borrow some of that money, you'll really mess things up. There are rules, conditions and penalties for retirement account loans. But the biggest penalty of all is that your dollars will not grow as much as they will if you leave the money untouched. I know, growth is slow, but it's growth nonetheless.

There are many reasons not to borrow from a retirement account, but I think the biggest is that should you leave your job for any reason, that loan becomes all due and payable. You'll have a couple of weeks to come up with the money. And if you can't, the loan will be automatically converted to a cash withdrawal. With the penalties and taxes you would owe on it right away, it could cost you up to 50 percent. Gone. Vanished into thin air. That is just too risky.

Here's an example: Say you borrowed $15,000 from your 401(k) for your daughter's wedding. You felt OK about it because you immediately started a repayment plan, which included interest.

A couple of months later you get a pink slip — a shocking, unexpected layoff. You get a notice that you have 14 days to come up with the entire loan amount, which is $14,650. You can't do it!

The plans administrator immediately converts that $14,650 to a cash withdrawal. BAM! Just like that, you owe a 10 percent penalty on the entire $15,000. Then, the $15,000 is immediately reported to the IRS as ordinary income, upon which you owe federal and state (if any) income tax. Your federal tax rate is 28 percent, and since you live in California, you must also pay a 10 percent state tax. That's $14,650 x 0.48 (10 percent + 28 percent + 10 percent), which equals $7,200. You owe $7,032 in taxes. Can't pay them? Well, then you'll have to agree to a payment plan with the feds and state tax board, which will include interest, of course. Ka-ching!

Whatever will you do? You don't have a job, and you already can't pay your bills. How will you take on two more monthly payments due to creditors, who will be anything but understanding, kind and forgiving should you fall behind?

Thankfully, this was only an example. You can still reconsider taking a loan from your retirement account. Here's my suggestion: Don't! Do not even think about it. The money in your retirement account will become your safety net in the future. Live as if the money doesn't even exist. Just save it, then forget about it.

Mary invites questions, comments and tips at [email protected], or c/o Everyday Cheapskate, 12340 Seal Beach Blvd., Suite B-416, Seal Beach, CA 90740. This column will answer questions of general interest, but letters cannot be answered individually. Mary Hunt is the founder of, a personal finance member website and the author of "Debt-Proof Living," released in 2014. To find out more about Mary and read her past columns, please visit the Creators Syndicate Web page at

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