When you are younger and just starting out at that job that actually offers a decent 401k, retirement seems so far off. Each week when your paycheck comes you barely notice the money coming out that goes directly to your retirement account. That money accumulates to where you eventually have a decent amount of money in there. Then the emergency comes up and you look around to see where you can get at some money. The emergency can be anything from medical, financial and even job loss. The problem is that no one will lend money when you hit these three issues. What you have left is accessing whatever you have on hand. If you created an emergency fund you can always go there but what if you have not yet? The alternative is to access your tax deferred retirement account. Tax deferred, meaning that you do not get taxed on it until you take the money out.
That is where it gets a little sticky. You have a choice; leave the money in or take it out for the need you have right then. The issue is that if you take any money out of a tax deferred retirement account you will get taxed on it as regular income and get a penalty of 10% if you are under 59 ½. Which means that you will in essence be taxed anywhere from 25% to 35% on your money if you take it out early. In other words you could lose $25 to $35 for each $100 that you take out just in taxes and penalties. The other issue is that any distribution is considered regular income so you need to be aware that you may bump yourself into a higher tax bracket depending on the size of your distribution. Events happen that are out of our control everyday. The key is to make sure that you control what you can and make sure that if you do have to take money out of a tax deferred retirement account that you understand the tax implications before you move forward. What will it do to your tax bracket? How much are you going to lose in taxes and penalties if you do take it out? Is there anywhere else I can go to that will not hurt my bottom line so much?