During my years of reporting on Americans’ personal finance concerns, I have often reported on one major warning about 401(k) plans and Individual Retirement Accounts (IRAs).

That involves a commonly enforced 10% federal penalty tax on top of regular income tax for withdrawals made from these accounts.

Financial services firm Fidelity highlights this fact when discussing whether one should choose a traditional retirement account or a Roth. The company emphasizes the need to consider a few factors up front when making this decision.

“Will you need access to funds before age 59-and-a-half?” Fidelity asks. “While you should strive to keep your retirement savings earmarked for retirement, sometimes life throws a curveball.”

“Contributions to Roth IRAs, including those rolled over from a Roth 401(k), can be accessed tax-free and penalty-free at any time,” Fidelity added. “If you withdraw more than your contributions, you may be subject to taxes and penalties.”

Another consideration is that Roth IRAs are not subject to required minimum distributions (RMDs), so a person’s money can remain invested for as long as they like and continue growing tax‑free throughout retirement.

By contrast, traditional IRAs and 401(k)s must begin distributing funds once one reaches age 73.

Fidelity explains traditional 401(k)s, IRAs, Roth accounts

Retirement plans such as 401(k)s, 403(b)s, and IRAs share many similarities. Each one provides tax advantages that can help savings grow either tax‑deferred or tax‑free.

The main distinction between a traditional account and a Roth version comes down to how and when one’s money is taxed.

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“With a traditional account, your contributions are generally pre-tax (401(k)) or tax deductible for IRA,” Fidelity wrote. “They generally reduce your taxable income and in turn, lower your tax bill in the year you make them. On the other hand, you’ll typically pay income taxes on any money you withdraw from your traditional 401(k), 403(b), or IRA in retirement.”

“A Roth account is the opposite,” Fidelity continued. “Contributions are made with money that has already been taxed (your contributions don’t reduce your taxable income), and you generally don’t have to pay taxes when you withdraw the money in retirement.”

AARP warns against knee-jerk 401(k) decisions

Recent downward trends in stock values are causing some Americans to get skittish about their investments, but retirement advocacy group AARP raises a red flag for people worried about their 401(k)s.

CFRA Research chief investment strategist Sam Stovall found that stock market declines of 5% to 9.9% typically regain lost ground in about six weeks. Corrections of 10% to 19.9% recover in a bit less than four months.

“The moral: Don’t make knee-jerk decisions regarding your 401(k) when the market plunges,” wrote AARP. “Stay calm and keep up with your contributions. That may not sound very exciting, but it is generally your best option for lasting wealth, research shows.”

Fidelity shows striking stock portfolio example

AARP outlines a hypothetical stock portfolio Fidelity used to illustrate the importance of investing for the long term.

• Fidelity modeled how a $10,000 investment made in 1980 would have grown through 2022.
• An investor who stayed fully invested for the entire period would have seen the balance rise to about $1.082 million.
• Missing just the five strongest market days would have reduced the ending value to $671,051.
• Skipping the 10 best days would have lowered the total further to $483,336.
• Missing 30 of the top-performing days would have left the account with only $173,695.

(Source:AARP)

“To stay the course during turbulent times, you’ll need to keep your instincts in check and put some guardrails in place,” wrote AARP.

Fidelity and AARP warn Americans on penalties associated with early withdrawals from retirement plans.

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AARP says stocks should not be one’s only asset

If a person’s 401(k) is 100% invested in stocks, they may be more likely to panic during a down market.

“One way to avoid that emotional response is with proper asset allocation, with your portfolio spread out between asset classes,” AARP suggested.

“Have some stable things in your portfolio like certificates of deposit, cash and bonds,” said Rob Williams, managing director of financial planning at the Schwab Center for Financial Research.

“(A diversified portfolio) will provide a cushion, so you have some money that won’t move around in value as much,” Williams added. “That knowledge will keep you from any extreme reactions.”

Market drops are never pleasant for investors who are already in the market, but the outlook changes depending on one’s position. For people looking to put new money to work, downturns can actually create attractive buying opportunities.

“Short-term blips can be buying opportunities,” said Dan Egan, director of behavioral finance at investing platform Betterment. “It’s a good time to get stuff on sale.”

“In the short-term, things feel scary,” he added. “But it is actually a nice moment to take advantage of other people’s panic.”

Related: Jean Chatzky sends blunt message to Americans on 401(k)s, IRAs