Multiple Streams Income

Don’t worry, I’m not going to re-hash the same tired financial advice you’ve always heard about the tax advantages of your 401k. Rather, I’m going to explain to you how the company you work for is actually paying for you to withdraw your retirement savings early.

If your job offers an employer match to your retirement account contributions – normally 50% of your contributions, up to a certain percentage of your salary – they will offset the taxation you’ll undergo if you pull that money early. Obviously if I want to retire early and liquidate my 401k, Uncle Sam is getting a huge slice of my pie. The key lies in the fact that as your employer matches 50% of your contributions, this results in employer-contributed funds amounting to 33% of your final account balance.

So let’s say I make $50,000 a year and I contribute 4% of my salary to my 401k. If my employer match is half that (2% in this case), I’m putting down $2,000 a year and my employer is contributing $1,000. Now to simplify this example, let’s say I have been working for ten years and I have $30,000 amassed. Again, for simplicity, we’ll say the market has been fluctuating so much that I’ve come out break-even. Doesn’t really matter how much extra I’ve earned for the purposes of this example.

$10,000 of the balance has been put there by the company I work for. Were I to withdraw the whole $30,000 early, I’d take a 35% tax penalty on the balance (25% tax bracket + 10% early withdrawal penalty). That comes out to $10,500 – just slightly more than the amount my employer has contributed. So essentially, I’m getting back just about all the money I put into my 401k – before taxes.

Now consider this: if I were to have put that money into a Roth IRA instead, I’d be subject to normal taxes before it went in anyway, right? So let’s say that 4% ($2,000) per year is taxed at 25% and put into a Roth. Not only do I not have the cushion of my employer match if I do wait until full retirement age to withdraw; I’m also only able to contribute $1,500 per year to my Roth. After ten years I’d have $15,000 assuming a break-even earnings rate.

In essence, this simplistic example shows how the employer match granted by the company you work for actually pays for you to take your retirement money early. I’m not trying to advocate that you pull your 401k before you’re due – that would be stupid, unless you are already set up and don’t need the full balance to live out your remaining years. As for myself, I plan/hope to retire well before age 59.5, so taking an early withdrawal of my balance is something that may one day become a legitimate option for me.

Most (if not all) financial advisers will caution you strongly against early withdrawals from a retirement account, unless it’s your last option, and your multiple streams income are not yielding enough for you to stay out of some seriously insurmountable debt. This example is simply to illustrate the fact that, on a worst-case-scenario basis, liquidating early will net you all the pre-tax money you’ve put into your account in this scenario. That’s not to say how much you stand to lose by making such a move, though.