When Minnesota Gov. Tim Walz’s daughter entered college, the current candidate for vice president on the Democratic Party ticket made a $135,000 withdrawal from a workplace retirement account to help pay for her educational costs.
Any parent can understand Walz’s decision. But was it wise? Without knowing the precise circumstances, it’s hard to say.
Walz turned 60 in April but made the withdrawal last year. Although the press has widely reported that he made an “early withdrawal” — which typically means one before the age of 59.5 — it’s possible he withdrew the money after that age.
But whether the withdrawal was early or not, pulling such a massive amount of cash from a retirement fund in a single year can be a bad idea for many people. Here are some reasons why it is often a mistake.
You might face an early withdrawal penalty
When you prematurely withdraw money from a retirement account, you often owe a 10% penalty on your withdrawal.
It’s important to note that there are exceptions to the rule.
One of the exceptions is for educational expenses, but that exception only applies to individual retirement accounts (IRAs), not workplace retirement accounts. That means Walz’s withdrawal likely was not eligible for this exception.
Again, we don’t know for sure that Walz made an early withdrawal. And even if he did, we can’t be certain that he did so under circumstances that triggered a penalty.
But in many situations, pulling money prematurely from an IRA or workplace retirement account is going to mean paying a 10% penalty, which will put a crack in your nest egg.
The withdrawal could be considered taxable income
When you withdraw money from a tax-advantaged account like an IRA or 401(k) prematurely, you typically have to pay federal income taxes on the cash. Combined with the withdrawal penalty, this can be a double whammy that seriously reduces the number of dollars that actually end up in your pocket.
So, making a premature withdrawal — or even making an especially large withdrawal in a single year after age 59.5 — can boost your tax bill for the year in which you pull out the cash.
And if you were counting on a tax refund, that plan might go up in smoke due to the taxes you owe on the withdrawal.
You stand to pay a higher tax rate on the withdrawal
If the withdrawal you make is especially large — as it was for Walz — there is a good chance it will push your income for the year into a higher tax bracket. That’s because the withdrawal itself will be combined with your job salary and other sources of income in determining your taxable income.
That means your withdrawal might come with the sting of a higher tax rate — possibly much higher — than you would have paid if you waited until retirement to make the withdrawal.
You lose out on growth
When you pull money out of your retirement account, it has two potentially devastating impacts:
- The money stops growing, and so does a portion of your next egg.
- Your ability to continue to defer taxes on the principal amount or investment gains ends.
Again, it’s important to avoid making blanket statements. In some circumstances, it’s possible that an early withdrawal can be the right move. It might actually save someone money in the long run.
But in many more situations, withdrawing money early — or simply withdrawing a large amount in a single year — can damage your retirement savings so significantly that you never fully recover.
You risk your retirement
At the end of the day, the single worst outcome of making an early or large withdrawal from a retirement account is that doing so can put your retirement at risk.
There are usually better ways to finance your child’s education than raiding your retirement account. For example, many experts have emphasized that while you can always apply for student loans for your kid, you can’t get a loan for your own retirement.
Using your retirement account to pay for tuition might save your child some financial pain now. However, it could simply delay much bigger pain if your child has to find a way to dig deep to help you finance your retirement later.
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