The temptation to tap your retirement funds often comes when you switch jobs and must decide how to handle it. If you are leaving your employer and must terminate your retirement plan, the smart move is to roll the money over into another tax-deferred retirement account, such as a Rollover IRA or your new employer's qualified plan.
Let's say you are taking a new job and you need $20,000 to buy a new car for commuting. Taking the money from your 401k will will hurt you in two ways:
1. You lose future retirement funds that could continue to build up tax-deferred.
2. You must pay a painful tax price. Combined federal and state taxes and early withdrawal penalties can take away more than 50 cents on every dollar withdrawn early, depending on your tax bracket. That means you might have to withdraw as much as $40,000 in order to get the $20,000 you need to buy the car.
As you can see, this can be an extremely expensive way to finance a car. You are far better off getting a conventional car loan or obtain an equity line of credit using your residence as collateral (interest paid may be tax deductible). Another option if you desperately need money: check into borrowing against your 401k balance, rather than withdrawing the money outright. However, be thoughtful of the withdrawal penalty and taxable income on any remaining balance if you decide to leave the job before paying off this loan.
