In my previous post, I described the importance of contributing to a 401k and how you should never take a withdrawal unless you absolutely have to. However, in some cases it just makes sense.
Unfortunately, I know some people who say they can't afford to save money into a 401k. They feel like every dollar of their paycheck is already spoken for. I get it -- life is expensive. But here is the thing: these individuals are still leaving excess money on the table.
The Strategy: Contribute, Match, Then Withdraw
If a company permits early 401k withdrawals, it is in your best interest to contribute enough to receive all of your company's contribution. Even if you find you definitely need the money right now, you can withdraw the funds afterward. Yes, you will have to pay taxes and a 10% penalty on the withdrawal, but you will still come out ahead after receiving your company's contribution and paying taxes on it.
Withdrawing money from your 401k is never ideal, but sometimes it just makes sense. If you are not contributing because you just can't afford it, it is beneficial for you to contribute, receive your company's match, and then withdraw.
Not contributing to your 401k because you "can't afford it" might actually be costing you money. The company match can outweigh the penalties.
The Math: How You Still Come Out Ahead
You can see how this all works out below. The example shows an employee making $50,000 a year with a company that provides a 6% match on the first 6% that they contribute.
| Item | Amount |
|---|---|
| Annual salary | $50,000 |
| Your contribution (6%) | $3,000 |
| Company match (6%) | $3,000 |
| Total in your 401k | $6,000 |
| Federal income tax (22%) | -$1,320 |
| Early withdrawal penalty (10%) | -$600 |
| Estimated state tax (~7%) | -$420 |
| Cash you receive after withdrawal | $3,660 |
| Your original take-home cost* | $2,010 |
| Net gain over not participating | $1,650 |
*Your $3,000 contribution was pre-tax, so it only reduced your take-home pay by approximately $2,010 after tax savings.
After you pay taxes and the withdrawal penalty, you still come out $1,650 ahead compared to not contributing at all. That is $1,650 you would have simply left on the table. Even if your company only contributes 1% to your 401k, you still come out ahead.
Important Caveats
Before you run off and do this, there are a few things to keep in mind:
- Not all plans allow in-service withdrawals. Check with your HR department or plan administrator to see if early withdrawals are permitted while you are still employed.
- Vesting schedules matter. Some companies require you to be employed for a certain number of years before their matching contributions are fully yours. If you are not vested, you may not be able to withdraw the match portion.
- This is a last resort, not a strategy. If there is any way you can leave the money in your 401k and let it grow, that is always the better option. Compounding is your best friend.
- The penalty only applies before age 59 1/2. If you are close to retirement age, the math changes significantly in your favor since there is no 10% penalty.
Who This Is Really For
This advice is specifically for people who are not contributing anything at all because they feel they cannot afford to. If you are already contributing to your 401k, even a small amount, keep doing that and try to increase it over time.
But if you are one of those folks sitting on the sidelines watching free money go unclaimed, this is your wake-up call. Even in the worst-case scenario where you need to withdraw everything immediately, the company match still puts you ahead.
I rarely recommend that anyone ever withdraw anything from their retirement account. But if you are not contributing in the first place because of financial constraints, it is worth it to contribute, grab the company match, and withdraw if you must. Something is always better than nothing -- and in this case, something comes with a $1,650 bonus.
