Millennial workers are feeling the effects of the COVID-19 pandemic and the recession that's followed in its wake. Many have been laid off and are struggling to pay their bills, despite unprecedented government aid, which has led some to make some risky decisions that could haunt them for decades to come.
Approximately one in three millennials have already taken a loan or a withdrawal from their retirement account or plan to do so, according to a Transamerica survey. If you have exhausted all of your other options, this is certainly better than falling into debt and ruining your credit, but it's not without cost. Here are a few things you need to know before deciding if it's the right move for you.
Withdrawals cost you more than the money you take out
When you withdraw money from your retirement account, you may only see a loss of a few thousand dollars, but you're overlooking the lost investment earnings you could've had if you've left that money alone. A $5,000 withdrawal today doesn't seem like a big deal, but if you'd left that $5,000 alone and it earned a 7% average annual rate of return over 30 years, it would have been worth over $38,000.
The fact that retirement accounts aren't worth what they were even six months ago complicates this problem further. If you wanted to withdraw $5,000 from your retirement account at the start of 2020, you would have had to sell fewer of your assets to get those funds than you would if you tried to withdraw the money right now, and that can further slow your progress toward your retirement savings goals.
This affects all individuals who take early withdrawals from their retirement accounts, regardless of their generation, but it hits millennials especially hard because their retirement contributions at this stage in their careers are so critical. Money you contribute early on in your working life has more time to grow, so it ends up being worth more by the time you retire than contributions you make later. By withdrawing retirement funds now, you're forgoing tens or even hundreds of thousands of dollars in investment earnings, and it will take substantially larger personal contributions in the future to make up for this.
Alternatives to early retirement account withdrawals
Before taking money out of your retirement account, you should use up your emergency fund and any other personal savings you have on hand. You should also do your best to cut back spending to just the essentials so you have less money going out every month. If that's not enough, explore other options, like a personal loan, to help you make ends meet. This will give you another monthly payment to worry about, though, so it may not be right for everyone.
Avoid charging expenses you can't pay for now to a credit card unless you're in a 0% introductory APR period and you feel pretty confident you will be able to pay back what you owe before the 0% APR period expires. You should also avoid payday loans. Their astronomical interest rates often make debt problems worse instead of better.
What to do if you need to withdraw retirement funds early
Sometimes, there may be no good way around an early retirement account withdrawal. It's not ideal, but it doesn't have to mean the end of your plans for retirement either. You just need to craft a new savings plan that takes into account where you are now and where you want to go.
Use a retirement calculator to estimate how much you must save going forward to retire on your original schedule. If it asks for an estimated investment rate of return, use 5% or 6% so your plan isn't thrown off by below-average investment growth. Once you've entered all your information, it should tell you how much you need to save per month and overall to reach your goal.
If you're unable to save as much as you need to, you may have to rethink your retirement plan. Delaying retirement by a few months or years is one of the best ways to shore up your savings because it gives the money you have more time to grow while also reducing how many years of savings you need. It also gives you more years to contribute to your retirement account.
When you withdraw funds from a tax-deferred retirement account, like a 401(k) or traditional IRA, you must prepare yourself for taxes this year as well. The government is giving people the opportunity to spread COVID-19-related distribution taxes out over three years so they don't have to stomach an extra-large tax bill this year, so this is something to consider.
Early retirement account withdrawals might be necessary for some people right now, but it's not a decision you should make lightly. You should only do so if you've exhausted all of your other options and you understand the consequences of your choice as well as what you must do to make up for it later on.