Don't make a hasty decision: All you need to know about early 401(k) withdrawals.

Hardship withdrawals are understandable, of course — life happens and sometimes in a financial emergency, taking money from one’s 401(k) is the only viable option. With the Federal Reserve reporting that credit card debt in the U.S. surpassed $1 trillion for the first time earlier this year, it’s clear that many families are stretched thin financially.

In some cases, however, the early withdrawals don’t appear to be hardship related. One study found that more than 40% of people cash out some or all of their employer-sponsored retirement accounts when they leave their jobs. This doesn’t include withdrawals that result in a rollover to an IRA or their new employer’s 401(k); these are cash-outs that will, in most cases, incur a tax penalty.

Those are big numbers, and they are likely to have significant ramifications. Withdrawing 401(k) funds before age 59½ triggers a 10% early distribution tax. The money also counts as income, so it’s taxed just like any other source of income — and that’s in addition to the 10% penalty.

“In addition to tax penalties associated with early withdrawal, there are income tax ramifications at any age when a withdrawal is made from a traditional 401(k)” says Elizabeth Bartlett, a financial planner with Commerce Trust.

To give an example of the potential tax impact, let’s say you withdraw $10,000 from a 401(k) before age 59½. The 10% penalty means the government keeps $1,000 to start with. Since the $10,000 is also taxed as income, you might only be able to keep roughly $5,300 to $7,800 of that withdrawal, depending on your tax bracket. That’s a significant hit.

Under certain conditions, you may be able to avoid the 10% penalty. A few examples include:

• You leave your job in the year you turn 55 or later.
• You are disabled, or you become disabled.
• You have to split up a 401(k) due to a divorce.

Depending on your situation, you might also qualify for a hardship withdrawal, as outlined in the Secure 2.0 Act that passed late last year. That legislation requires you to have an “immediate and heavy financial need” for an early 401(k) withdrawal, and it only covers the amount required to meet that need. Things like medical bills, funeral expenses and payments necessary to avoid eviction or foreclosure on a primary residence can all potentially qualify for this provision, which would allow you to avoid the early withdrawal penalty.

However, there’s more to think about than the 10% penalty. One of the big advantages of a 401(k) account is that it compounds over time, and the longer one leaves money in it, the greater the accumulation. When you take a withdrawal, you cause yourself to miss out on all the compounding that money would have provided for you had it stayed in the account.

In other words, early withdrawals can leave you with a lot less to fall back on in the future, when you’re looking to retire. It raises the risk of possibly outliving your savings. If you’re early in your career, you might have time to be able to catch up, but the closer you are to retirement age, the harder it gets.

“Each and every asset you hold should have a purpose. 401(k) plans are no exception. They are designed to help fund our needs and support our lifestyle during retirement years,” says Bartlett. “Ideally, these funds should remain invested and untouched until we’ve stepped away from the workforce.”

Regardless of your situation, if you’re thinking about making an early withdrawal from a retirement account for any reason, it’s recommended that you consult a tax professional and/or financial advisor first. They can help you make an informed decision and even explore alternate ways to secure the money you need, such as taking out a loan on your 401(k).

The decision of whether or not to make an early withdrawal from your 401(k) account is a complex one. There are a number of factors to consider, including the tax implications, the impact on your retirement savings, and your financial situation. Making a well-informed decision is the best way to ensure that you have enough funds saved for retirement and a secure financial future.