When you're in your 40s, it becomes harder to bounce back from retirement savings mistakes as you get closer to the time you'll leave the workforce.
Unfortunately, millions of Americans in this age range have made a big error: withdrawing from their retirement accounts. In fact, according to a recent TD Ameritrade survey, 46% of Americans between the ages of 40 and 49 have tapped these accounts already.
This is a really big problem for two reasons.
1. Withdrawing from retirement accounts could trigger penalties
Tax-advantaged retirement accounts are designed to support you during retirement. If you take money out of a 401(k) or an IRA before you turn 59 1/2, you'll likely be subject to a 10% penalty from the IRS. If you withdraw $5,000, that would cost you $500. You'll also be taxed on the withdrawal as ordinary income, which further eats away at the funds you've taken out.
There are a few situations where you can withdraw money early without incurring penalties, including if you need it for medical expenses or to repair a severely damaged primary home. In fact, the IRS allows penalty-free withdrawals from a 401(k) or IRA when you have an "immediate and heavy" financial need. But your employer's 401(k) plan may not allow this. And if you can do it, you're allowed to take out only enough to deal with the pressing need.
You can also borrow against a 401(k) and pay yourself back with interest over as long as five years. But this is risky because if you lose your job or leave it for any reason, and you don't pay back the money before the end of the tax year, your loan will be treated as a withdrawal and you'll be subject to penalties.
2. Reducing your retirement savings could leave too little to live on
When you withdraw money early from retirement accounts, you don't just lose a portion of the money to the fees you owe. You also lose the gains that money would have made had you left it invested until retirement. And because of compound interest, an early withdrawal can have an outsize impact. A $10,000 withdrawal at 40 would reduce the size of your account balance at 65 by about $55,000 compared with what it would've been had you left the money alone (assuming a 7% annual return on investments). Obviously, larger withdrawals will have an even bigger effect.
Many people in their 40s already have too little saved for retirement. In fact, the same TD Ameritrade survey also revealed that two-thirds of people in this age range have less than $100,000, leaving millions short of experts' recommendation to have double their annual salary saved by 40. Raiding your retirement savings account will only make your situation worse.
You can't afford to make early withdrawals from a retirement account
If you're among the 46% of Americans in their 40s who have withdrawn money from retirement accounts, there's still time to bounce back from your mistake. You may need to increase your savings rate to make up for it, but you have decades left until retirement to build the nest egg you need.
And no matter your age, if you haven't yet made an early withdrawal, try to avoid it at all costs. It's not worth the tax penalties, and even if it were, you don't want to rob your future self of financial security.