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“The long-term consequences of this are going to be very painful,” he tells CNBC Make It.
If you’re considering cashing out your 401(k) to cover your expenses after a layoff, there are a few big reasons why financial experts say it should be your last resort. This is what you should know.
One of the main reasons financial experts advise against withdrawing money from your 401(k) after being laid off is the potential tax consequences. You will generally have to pay income taxes on any money you withdraw, which could result in a higher tax bill.
Let’s say you withdraw $100,000 from your 401(k) after you get laid off. At tax time, that money will be combined with your previous annual income and may result in you moving into a higher tax bracket, Lester says.
In addition to potential local, state, and federal taxes, you may also owe an additional 10% tax penalty for withdrawing your retirement funds before you turn 59½. according to the IRS. Under certain circumstances, a hardship withdrawal is possible without penalty, but specific conditions must be met.
And since taxes and fines can be quite expensive, you may end up with less money than you initially expected, Lester says.
“You can look at the number in your 401(k) and think ‘Oh my gosh, I have $100,000,’ but you don’t actually have $100,000,” he says. “Depending on your tax bracket, you may only receive half that amount.”
In addition to potentially facing a costly tax bill, cashing out your 401(k) can negatively impact your ability to achieve your long-term retirement goals.
When you withdraw funds invested through your 401(k), that money loses the opportunity to continue growing thanks to the power of compound interest. While you can invest more money later, you won’t be able to get that time back.
“The greatest money-making asset anyone can possess is time,” Ed Slott, editor of IRAHelp.com, previously told CNBC Make It.
On top of that, cashing out your 401(k) means you’re basically restarting your retirement savings journey. It may be difficult to recover your funds to the level they were previously.
Instead of tapping into your retirement savings, there are a couple more options you can consider if you’ve experienced a layoff and need cash to cover everyday expenses.
Try a 0% interest credit card
While relying on credit cards shouldn’t be your first choice either, if you don’t have emergency savings or another source of income available, you may want to use them temporarily to cover your living expenses, Lester says.
“If credit cards are the only way you can eat and you’ve eliminated all other spending, then yes, put some things on a credit card,” he says. “But it’s not a strategy, it’s a desperate move.”
This is because credit card debt can quickly grow to an unmanageable amount due to high interest rates.
If you must rely on credit cards to cover your living expenses after being laid off, a card that offers a 0% interest period can help you avoid costly interest charges sometimes for up to 21 months.
But it’s important to note that not everyone qualifies for this type of credit card, as a good to excellent credit score is typically needed. Additionally, opening a new card may temporarily lower your credit score.
Apply for unemployment benefits
Another option is to see if you qualify for unemployment benefits in your state, Lester says.
Although each state uses a different set of rules to decide who qualifies for unemployment benefits, you will typically qualify if you were fired from your job through no fault of your own, according to the US Department of Labor.
You will need to file your claim with the state where you worked and provide information such as your address and dates of employment. It is usually best to apply as soon as possible, as it may take a few weeks until you receive a check.
“You have to apply as soon as possible,” says Lester. “This is not the time to think, ‘Oh, I can’t do that. It’s embarrassing.'” “There is no shame in being laid off or receiving unemployment benefits.”
It’s also important to note that the amount you receive will generally be based on a percentage of your earnings during the last 52-week period and will be capped at the state maximum amount, according to the Department of Labor. Additionally, you can receive unemployment benefits for a maximum of 26 weeks in most states.
For more information on eligibility guidelines, see the Department of Labor’s page. unemployment insurance fact sheet and map of unemployment insurance offices.
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