Here's What Cashing Out Your 401(k) at 28 Really Costs You by Age 65
So, you’re 28, cash-strapped, and are sitting on a few thousand dollars in a 401(k) from your last job. Cashing out your 401(k) can feel like a quick solution since you have several decades to save for retirement. However, doing so will quietly cost you hundreds of thousands of dollars by retirement.
Here’s what cashing out your 401(k) at 28 really costs you by age 65 and why it’s often one of the most expensive financial decisions you can make.
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Taxes and Penalties
Withdrawing from a 401(k) before the age of 59½ usually triggers a 10% early withdrawal penalty and ordinary income taxes on the amount. Depending on your tax bracket, that’s a huge chunk gone before hitting your bank account.
Let's say you cash out $30,000 and fall in the 22% tax bracket; you'd pay $6,600 in federal income taxes plus $3,000 in early withdrawal penalties, leaving you with only $20,400. There are also state income taxes, which can shrink that amount further, depending on where you live.
Remember that a large withdrawal could push you to a higher tax bracket, increasing your overall tax bill for the year.
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Lost Compound Growth
Money in a 401(k) grows through compounding. When you withdraw early, you lose decades of growth.
If you plan to retire at 65 and withdraw at 28, that’s 37 years $30,000 would have potentially grown and compounded. Assuming a 7% annual rate of return, your $30,000 would be $366,708 by the time you reach 65.
While $30,000 might seem harmless at 28, it’s costing you thousands of dollars in compound growth.
Opportunity Cost
All 401(k)s have annual contribution limits, unlike regular savings. Once you cash out, you can’t replace it later beyond those limits. This means years of lost compound growth, losing tax advantages you can’t recover, and probably falling short of your retirement target.
Even if you increase contributions later, catching up can be difficult. This is because you’ll have lost the best days in the market where your money would have grown.
Alternatives to consider if you’re in a tight financial spot, here are better options to consider than cashing out your 401(k):
Roll it over: When you roll over your 401(k) into an individual retirement account (IRA), there’s a 60-day window for the funds to be deposited in your new account. During that period, you can use the money the way you want.
401(k) loan: You can borrow up to 50% of your vested balance or $50,000 from your 401(k), whichever is higher.
Hardship withdrawal: Some 401(k) plans allow you to cash out from your plan if you have an immediate and heavy need. However, the amount is directly proportional to the financial need.
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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