May 18, 2010
The one thing you can expect through the course of your life is unexpected expenses. Some turn out to be minor in scope but others can be quite damaging to the checkbook. A roof that needs to be replaced; a child that needs braces but doesn't have orthodontia; a car transmission that decides it has worked for long enough... the list goes on and on.
When these things arise, the first question is often "How am I going to pay for this?" and while I don't have the specific answer for you and your situation, I can tell you what to avoid: early distributions from your 401k or IRA. Your statement arrives every three months with an ever-changing account value, but what you will receive if you attempt to draw out that money is far less than the printed number.
Say you have built up $10,000 in a 401k at work. Surely you planned to use this to fund your retirement, but you weren't expecting your roof to start leaking and buckets of water to start falling onto your carpet. You get a repair estimate and low and behold it comes to $10,000...so you take the cash from your 401k and it seems like a wash: you lose your retirement savings but at least you have the full $10,000 for the roof, right? Not really. When you drew that money out of the account it became taxable income. If you are (for example) in the 25% tax bracket, right off the bat you're working with only $7,500. But you're not done yet. The IRS penalty is 10% for withdrawals for people under the age of 55 in a 401k or 59 1/2 in an IRA.
So that $10,000 shown at the bottom of your statement is actually more like $6,500 after Uncle Sam takes his cut and then hits you with a penalty for taking your own money. No one likes taking out loans, particularly lately, but odds are the interest rate won't be 35%. Some 401k's offer loan provisions so you can 'borrow' the money from your account as long as you promise to pay it back. As a last resort, you are able to take the money from your retirement savings (after all, no one wants to have water dripping on their face while they try to sleep!). Just beware of the implications of doing so. If there is another way to pay for it, odds are it may be the better way.
Steve Hicks
(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).