Even if Law Changes, Keep money in Retirement Plans

Both candidates for president are proposing allowing people to withdraw funds from their 401(k) without penalty due to the economic problems we are having. They are also discussing taxing these withdrawls at a lower rate than what the taxpayer's normal rate might be.

Under current law if you withdraw money from a retirement plan before age 59 1/2 you not only pay taxes on the amount you withdraw at your ordinary rate, but you pay an additional 10% penalty on the amount withdrawn assuming you do not meet one of the few exceptions that are available to withdraw from the account.

The reason a penalty exists in current law is to discourage people from dipping into funds that should be for retirement. If you pull money out it makes it difficult to catch up to the earnings you have lost and you lose out on the interest you could have earned on the money.

The problem I have with waiving the penalty is this. If we make it painless to withdraw money from retirement it could have a terrible impact in two areas. The first issue is that people will have made the mistake of withdrawing funds that they will need later. We could have a lot more people who are not ready for retirement because of this. The second impact is that if a substantive amount of people withdraw from the market it could make the drops we've had in the market seem like nothing.

It needs to be remembered that you have options in how your assets are allocated within a retirement plan. All of your funds need not be in the stock market. You can use cash funds or bond funds to limit your risk. By all means people should review their asset allocation, but letting people easily withdraw their retirement funds would be a disaster.