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Young Americans Are Making a Big Financial Mistake

By Motley Fool Staff - Dec 5, 2018 at 10:43AM

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The majority of the 18-34 age group is making a potentially costly error.

According to a recent study, nearly 6 of every 10 people in the 18-34 age group have tapped into their retirement savings early. While there are indeed some legitimate reasons for accessing retirement savings early, far too many people are treating their retirement savings like an ATM.

In this  Industry Focus: Financials clip, host Jason Moser and Certified Financial Planner Matt Frankel discuss why early retirement withdrawals are such a terrible idea.

A full transcript follows the video.

This video was recorded on Dec. 3, 2018.

Jason Moser: Alright, Matt, we were talking before taping about this article that we ran across over the weekend. It's disconcerting, to say the least. Apparently, most young workers are using their retirement accounts like an ATM. And that just doesn't sound good in any way, shape, or form.

Matt Frankel: Yeah, that's bad. [laughs] About 60%, I think 59% to be exact, of people in the 18 to 34 age group have tapped into their retirement savings. Clearly, these people aren't retired. Some of this, to be honest, was for a good reason. If you have, say, medical expenses that you have no other way to pay, that could be a valid reason to tap into your retirement money early. Same with if you're unemployed and have no other way to cover your day-to-day expenses. That can be a good reason.

But, just to run down some of the stats, 16% said they took the withdrawal to make a large purchase for themselves. 13% said it was just to spend the money. Another 7% said they took money out of their retirement to go on vacation.

First of all, none of those are allowable reasons to take your money out, so you're going to get slapped with a penalty for doing that. The IRS penalty for early withdrawals is 10%. And if you take it out of a tax-deferred account like a 401(k) or a traditional IRA, you have to pay tax on the money on top of that. So you're talking about, depending on your tax bracket, like a 30%-plus haircut right off the top when you take the money out.

The real bad reason is, you're robbing from your future self here. From the financial planner's perspective, let's say you have $5,000 in your 401(k) and you leave your job. You might want to take a vacation or something. If you withdraw that $5,000, that could easily become $3,000 or so after taxes and penalties. Meanwhile, if you leave that invested for 30 years, at just the average rate of return of the stock market over history, that $5,000 would become more than $76,000 by the time you're ready to retire in 30 years. $3,000 now, $76,000 later. Sounds like the biggest no-brainer of all time to me, but a lot of younger people are making the wrong decisions.

Moser: Yeah. I do remember, once upon a time, when I was that age, it's a little bit more difficult to see that far down the road, to actually believe that it really matters. It's very easy to say, "Nah, I'll just cross that bridge when I come to it." But the problem is, eventually, you do come to that bridge. And if you've been misbehaving all the way up there and spending your savings, well, then you're stuck with nothing, and you've wasted your biggest advantage in time. You can't make it up, you can't gain back what you lost. That's why we tell people, you have to get started immediately, right when you get that first job. Even if it's just 5%-7% of what you're getting paid. Just start putting that stuff away. Time is really what allows you to become rich if you just take the discipline to do that.

I tell you, withdrawing it for those types of reasons... I understand a medical emergency or something like that. And, I mean, you can borrow from your retirement account in some cases to make a payment on a house, and you can pay yourself back. There are qualified reasons for doing it. But just to spend the money, or a vacation or something like that? I personally would never do that. That could put people in a really big crunch when they get a little bit older.

Frankel: Yeah. Especially because a lot of them don't realize that it results in a big tax hit when you do that. They'll take this money out, then get to tax time in April, and, "Oh, jeez, I owe $3,000 to the IRS that I wasn't thinking of." That's a problem, too. And then they do it again, and they have to take that $3,000 out of their retirement account to pay the IRS, and the cycle repeats. It can become a real cycle, and it can be really tough to get back on track once you start withdrawing from your retirement account for silly reasons.

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