Millions of Workers Dipped Into Retirement Savings This Past Year. That's a Big Problem
- New data reveals that 18% of workers took money out of a retirement plan over the past year.
- Raiding an IRA or 401(k) could come with a host of unfavorable consequences, like not having enough money in retirement and having to pay a penalty.
Raiding your retirement plan could spell trouble down the line.
Workers are often told to save for retirement so they have access to enough money to pay their bills later in life. And it's a good idea to contribute steadily to an IRA or 401(k) plan, if your employer offers one.
But once money lands in your retirement account, it's really important you keep it there. That way, you can make sure it's accessible during your senior years, when you're apt to need it the most.
Unfortunately, over the past year, a good 18% of workers have dipped into their retirement savings, according to Salary Finance's fourth annual report. And that's a move worth avoiding for many reasons.
The dangers of taking money out of retirement savings
Any funds you remove from an IRA or 401(k) during your working years won't be available to you in retirement. And that alone is a problem.
But also, when you take money out of one of these plans, you don't just remove a chunk of your long-term savings. You also take away the option to invest that money and grow it into a larger sum.
Let's imagine your IRA normally delivers an 8% average annual return on your investments. (That's a little below the stock market's average.) If you take a $5,000 withdrawal 20 years before retirement, you won't just be out $5,000 later in life. Rather, you'll be out over $23,000 when you factor in missed investment growth.
Plus, most of the time, when you take money out of an IRA or 401(k) prior to age 59 1/2, you're assessed a 10% early withdrawal penalty on the sum you remove. So, let's say you need $5,000 in a pinch to cover a home repair. Remove that money at age 45, and you're looking at losing $500 of it right off the bat.
A better way to access cash
If you need money in a pinch and have equity in your home, borrowing against it could be a better option than raiding a retirement plan. You can take out a home equity loan and pay it off over time, for example, or apply for a HELOC (home equity line of credit) and access money from it when you need to.
If you don't own a home or have equity in one, you can consider a personal loan if a need for money arises. If you have good credit, you might qualify for a relatively low interest rate on one of these loans.
Keep in mind that if you have a 401(k) plan, you may have the option to borrow against it. In that case, you'll be paying yourself back, not a lender.
But there's a danger to taking out a 401(k) loan. If you don't repay it on time, it gets treated as an early withdrawal and the aforementioned penalty applies. Plus, you lose out on the chance to invest that money while it's out of your account because you've borrowed it.
Of course, the ideal way to address a need for money is to tap your savings account. But if you're at the point where you're thinking of raiding a retirement plan, it means you probably don't have money in regular savings to access.
If that's the case, work on building yourself an emergency fund as quickly as possible. That way, when a need for money arises in the future, you won't have to contemplate taking an early retirement plan withdrawal -- and facing unwanted consequences as a result.
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