Why Tapping Your 401(k) Early Can Sting

For young adults with high-interest debt and few other options, tapping into retirement funds can be tempting. However, there's one major reason why it's a bad idea: It can cost a lot more than it saves.

While the golden years can seem far off to those in Generations X and Y -- and immediate needs can seem more important -- it's wise to look for other options. Withdrawals or loans from retirement funds can come with hefty penalties, taxes and interest rates unless there is a severe medical or court-ordered hardship. Taking out cash also saps the compounding interest that is being earned.

"Unfortunately a lot of people between 22 and 35... see the 401(k) as sort of just a regular savings account," says Vincent Barbera, director of financial planning at TGS Financial Advisors. "You say, 'I need some cash and I'll just tap into that.' That's the worst mentality to have. That's really something you shouldn't even look at -- it's really the last, last, last resort."

Putting $5,000 toward retirement at the age of 25 will earn tens of thousands in dividends and capital gains over the next 40 years, according Barbera. Putting that same $5,000 into the fund over several years will significantly lower the returns.

Taking out cash not only lowers returns but costs a great deal: A $1,000 withdrawal from a retirement fund can cost up to $400 in taxes and penalties, Barbera says.

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