Whether you have a traditional Roth 401 (k) or a Roth 401 (k), you will have to pay a 10% penalty on withdrawals if you are under 59 1/2. You will also owe income tax on the withdrawal, depending on your current tax bracket.
You can avoid the 10% penalty if you live in an area affected by a natural disaster, excluding the Covid-19 pandemic. This recent change was part of the stimulus bill adopted by Congress in December 2020.
You will lose potential gains
One of the main disadvantages of early withdrawals from your 401 (k) is the loss of future compound interest. When you take money out of your investments, you lose all future income.
Let’s say someone in the 22% tax bracket withdraws $ 10,000 from their 401 (k) to pay off their student loans. They would end up paying $ 2,200 in taxes to the IRS at tax time, plus a 10% early withdrawal penalty of $ 1,000.
It might sound bad, but it gets even worse when you consider the long term consequences.
“This current cost is high, but not as high as the opportunity cost,” said Ben Wacek, founder and senior financial planner at Guide Financial Planning in Minneapolis. “If you had left that $ 10,000 in the account for the next 40 years to grow at 8%, you would end up with over $ 217,000.”