Why Cashing Out Your 401(k) at 55 Costs You $170K in Lost Growth

If you leave your job, you can access your 401(k) money without the 10% early withdrawal penalty as early as age 55. But that doesn’t necessarily mean age 55 is a “green light.”

If you look at the money that you’re leaving on the table by withdrawing it that early, it can be eye-opening.

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How Much a $100K Cash-Out Can Actually Cost

According to Vanguard, the S&P 500, along with its predecessor index the S&P Composite, produced an average annual return of about 10.5% since 1926.

Now, imagine a worker who leaves a job at 55 and cashes out a $100,000 401(k) fund. If that worker had instead left that money invested in the S&P 500 for another 10 years, to the common retirement age of 65. Using the historical average, that $100,000 could have grown to about $271,400 instead. That worker would be leaving over $171,000 on the table in just a single decade.

The real variable in the scenario is what a worker does with the money upon withdrawal. If used for living expenses and general spending, that worker could end up with $0 at age 65, instead of over $271,000 if the money was left in the 401(k) account. Plus, at age 65, that money would have to fund a shorter retirement. A withdrawal at age 55 means that money has to help cover an additional decade of life after work.

10 Years Is the Short Version

Although 65 has often been cited as a common retirement target, for most workers, the Social Security Administration considers 67 to be “full retirement age.” Some workers don’t tap their benefits until age 70.

If you extend the same $100,000 out to 15 years instead of 10, that balance would grow to roughly $447,200 instead of $271,000. That’s more than four times the original balance. As a side benefit, waiting to retire until age 70 would also maximize the amount of Social Security benefits the worker would receive. Payouts increase by 8% each year from age 67 to age 70, boosting monthly checks by 24% for those with the patience to wait, per the SSA.

You Still Owe Taxes

Although you can sidestep the 10% early withdrawal rule by separating from an employer at age 55, you still can’t avoid the IRS. The money you withdraw from your 401(k) plan is fully taxable as ordinary income, whether you take it out at age 35, 55 or 75.

Depending on your outside income, this could amount to a huge tax bill. If you work a full year, retire in December and withdraw from your 401(k) acount that same year, for example, you’d be adding a retirement distribution on top of your full year’s income. That may be enough to push you into a higher tax bracket.

It also means that a $100,000 withdrawal from a 401(k) fund doesn’t translate to $100,000 in a bank account. After federal, state and local taxes, where applicable, that withdrawal could be slashed by 30% or more.

Every person’s financial situation is different, and for some workers, taking a penalty-free distribution at age 55 can make sense. But there’s a definite trade-off in terms of future growth, and it’s something worth planning around.

This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.

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