November 3, 2004
We're not a country that's fond of delayed gratification. (Take a gander at personal debt statistics if you're curious about the Joneses' Visa bill.) But when it comes to retirement savings, it pays to resist the temptation to take an early dip -- even when Uncle Sam allows it.
Perhaps you've eyed your IRA savings when facing higher education costs. Many first-time homebuyers have taken a penalty-free loaner (up to $10,000) to cover some of their costs. Or maybe your family has been sacked with extremely high, unreimbursed medical bills that could be covered only with funds earmarked for retirement. For those with limited resources, dipping into IRA money early is the only way to get to college, become a homeowner, or cover catastrophic medical expenses.
In any other situation when you might be tempted to borrow money from your IRA before age 59 1/2, don't do it. The price in taxes and early withdrawal penalties is too steep.
Take, for example, Jim, who invested $2,000 in a Roth IRA seven years ago. Earning the stock market's average returns, today his balance is $3,500. When his brokerage account statement arrives, Jim doesn't see retirement dreams; he sees dollar signs. His neighbor is selling a really hot car that -- like a sign from above -- is going for exactly $3,500. Jim cashes out his IRA so he can get behind the wheel by the weekend.
However, Jim has a problem. He still can't afford the car even though he thought he had it covered. After paying taxes on his Roth earnings of $1,500 at his marginal tax rate (let's say that he's in the 28% tax bracket) as well as shelling out a 10% early withdrawal penalty, Jim's $3,500 Roth becomes a pip-squeak $2,900.
Had Jim been able to resist the new ride or been able to come up with the money without touching his retirement funds, he would have been a lot better off. Had he just let his IRA ride it out for the next 30 years (at the stock market's average annual returns) it would have been worth more than $20 grand.
Sometimes resistance is fruitful.
- How can you access Roth IRA funds without paying a penalty? Robert Brokamp argues that sometimes using the Roth as an emergency fund makes sense.
- For more on the nuts and bolts of opening an IRA, spend the next minute perusing our 60-Second Guide.