In debt? Leave your retirement account alone.

Almost everyone in New Mexico and across the country spends years saving up for retirement. 401(k)s and other retirement accounts are often a person’s most valuable assets, thanks to the long-term contributions that they and their employer make.

When people run into significant financial challenges, it can be tempting to dip into one’s retirement fund to pay off debts. It may seem like a quick-fix with fewer consequences than debt. However, there are three important factors everyone should consider before using any retirement funds.

1. There are penalties for withdrawing money from retirement accounts

Retirement accounts, pensions and Social Security benefits have an explicit purpose. They are meant to support individuals after they leave the workforce. The average age that individuals can begin collecting retirement is 62.

Withdrawing funds before the age of 62 can lead to severe penalties that impact finances and taxes. These penalties generally result in considerable fees and a 10% tax penalty on the amount withdrawn from an individual retirement account (IRA) or 401(k). That means that an individual would essentially have to pay 10% interest on any withdrawal they make.

These penalties may seem insignificant at the time of the withdrawal. However, they can quickly add up to substantial long-term losses.

2. It is difficult to rebuild those savings after withdrawal

The government protects retirement funds until individuals reach the age of 62. And even then, they still preserve the funds as individuals receive monthly incomes from their accounts.

There are a few challenges that result from an early withdrawal, including:

  • The government no longer protects the money
  • Creditors could access retirement assets after an early withdrawal
  • Rebuilding a retirement account takes a significant amount of time

3Retirement and pensions are often exempt in bankruptcy

Both New Mexico and federal bankruptcy exemptions protect pensions and retirement accounts. So, filing bankruptcy to discharge debts can help secure retirement funds for the future while also handling current financial challenges. It is also a way to help individuals avoid the serious penalties of early withdrawals.

However, taking money out of a retirement account before filing bankruptcy can undo any exemptions or protections. Many people agree that turning to a retirement account to pay off debts has more risks than benefits. Therefore, it is better to protect a retirement account for the future rather than use it to resolve current financial issues.