If you are like many people, you may easily spend hundreds of dollars or more on holiday gifts and related holiday purchases each year. Some sources1 indicate that consumers may spend more money over the holiday season this year than they have in previous years. The cost of gifts is only one seasonable expense. For example, you may have plans to host a party, to travel or to decorate the house elaborately. When you are preparing to spend a large sum of money within a short period of time, financial planning is necessary. Some people may be thinking about taking money out of a retirement account2 to cover seasonal expenses, but this is not advisable for many reasons.
The Tax Penalties
When you take money out of your retirement account before the withdrawal date, you face the expensive prospect of having to pay an early withdrawal penalty3. More than that, if you are taking money out of an account that used pre-taxed funds, you will also need to pay taxes on the amount of money that you withdraw. In some cases, this extra income that you are taxed on will bump you into a higher tax bracket. This can magnify the impact on your tax liability for the year. As you can see, it can be very expensive to pay for your expenses during the holidays through this type of funding.
The Impact on Your Financial Future
The impact on your finances is more far-reaching than simply having to pay a higher income tax bill. When you take money out of an account that was earmarked for the later years in life, you are decreasing the amount of money that you will be able to access. More than that, you miss out on the benefits of compounded interest, dividend reinvestment, and other methods for growing your money exponentially over time. The impact on your financial security can be stunning. Because of these factors and because of the tax penalties that you may face, the true cost associated with an early withdrawal may be much more substantial than what you may think.
A Better Solution for Shopping During the Holidays
Because of how expensive it can be to take money out of a retirement account to pay for holiday gifts, décor, travel plans and more, planning for a better solution is important. One idea is to begin setting aside money or even shopping for gifts several months ahead of time. By doing so, you are spreading out this expense over the course of several months rather than several weeks. Layaway is available at some stores as well. You can also consider using credit cards or even different types of loans to pay for the expenses. Loans and credit cards do have fees associated with them, but you may discover that these are more affordable options to consider than dipping into your 401(k) or IRA. Remember that you can always downsize your holiday experience or buy more affordable gifts if you lack the funds necessary to pay for everything without reaching for your IRA or 401(k).
Paying for gifts, travel and more this season can be a burden to your budget, and you need to approach this season with a solid financial plan. Rather than dip into a chunk of money that you have earmarked for your senior years, develop a better plan that may be more affordable for you over the long run. Before you start shopping and decorating your home, create a budget so that you know exactly how much money you will need. Then, create a feasible plan to pay for these expenses with ease.
Cheers to a smart holiday shopping season!