Over the last few months, the economic crisis and mortgage crisis have caused many people to lose large percentages of their retirement and investment portfolios. Losses of 40% or more are not uncommon. While this is devastating to those who are near retirement and is discouraging for everyone else, that doesn’t mean it all is lost.
Should I withdraw the money in my retirement accounts? I have received numerous questions from people asking if they should cash out their 401(k)s, IRAs, or other retirement plans. In most cases, the answer is a resounding, no. By withdrawing your money from your retirement accounts now, all you will serve to do is lock in your losses and possibly subject yourself to taxes and early withdrawal penalties. For most people, the best course of action is to leave your money in your retirement accounts.
Why you should leave your money in your 401k plan, IRAs, or other tax deferred investments
1. Avoid early withdrawal penalties and taxes. Early withdrawal penalties will eat your lunch. Before withdrawing your money from your 401k or IRA, you should keep in mind that you could pay early withdrawal penalties of 10% of your withdrawals and you may also be subject to taxes. Taxes and penalties could easily erase another 30% of your investment, on top of the 40% or so you have already lost.
2. Avoid locking in losses. At this point you haven’t actually lost any money – just the value of the shares. Selling your shares locks in the loss and turns a paper loss into a real loss.
3. Give yourself a chance to earn your money back. There is a good chance that the value of the shares in your retirement portfolio will increase in value, though it might take some time. Withdrawing your money removes any chances of recapturing the value of your investments.
4. Avoid handicapping your retirement. Withdrawing from your retirement accounts now means you will need to start saving for retirement again from scratch. Withdrawing your retirement savings, paying penalties and taxes, and locking in your losses will severely hamper your retirement plans.
What should you do with your retirement accounts?
At this point, the best thing you can do is stick to your retirement savings and investment plans. Continue contributing to your retirement accounts, make sure your asset allocation is set at your desired level, and don’t withdraw your retirement savings. The lower prices on the stock market means now may be a good time to invest and you may decide increasing your retirement account contributions is a good idea.
If the current markets make you nervous, consider investing in lower risk assets such as cash, money market accounts, bonds, and other low risk investments. This will keep your money in the tax deferred investment, prevent early withdrawal penalties and taxes, and give you the psychological advantage of not watching the value of your retirement accounts continually drop.