Retirement Accounts: Too Much of a Good Thing?

Is it possible to have too much money in tax-deferred retirement accounts? That might seem like an odd question given the oft-repeated advice to shovel as much as you can into 401(k) plans, traditional Individual Retirement Accounts and Roth IRAs.

And, indeed, if your employer offers a 401(k), 403(b) or similar plan, you should contribute at least enough to qualify for the company's full matching contribution. That match represents extra money that it would be foolish to pass up. Even without an employer match, your contributions to a 401(k) or traditional IRA may be tax-deductible. If you do the math, you may find the investment growth on these initial tax savings can end up paying for the taxes due when you make withdrawals. And, of course, tax-free growth is the big appeal of both Roth IRAs and Roth 401(k) plans.

The downside: It's difficult to tap these various retirement accounts before age 59½ without getting hit with early withdrawal penalties.

To be sure, there are exceptions. For instance, you may be able to borrow from your 401(k). But borrowing can be risky. In fact, 401(k) loans have to be repaid right away if you lose or leave your job. If you can't come up with the money to repay the loan, you could get hit with taxes and penalties.

Similarly, you can make a withdrawal from an IRA and avoid penalties (though not any income taxes that are due) if you meet certain conditions, such as making a first-time home purchase or paying for qualified higher education expenses. The Roth IRA also provides unusual flexibility: If you make a regular $5,500 annual contribution to a Roth, you can withdraw that contribution at any time and there won't be any taxes or penalties owed, provided you don't withdraw any of the account's investment gains.

Still, given all the restrictions that apply to retirement accounts, you may want to funnel some savings into a regular taxable account. That way, you'll be in better shape if you suddenly need money for a financial emergency. Building up your taxable account can also be a smart move if you hope to retire before age 59½, because you won't have to worry about the penalty on early retirement-account withdrawals.

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