Worried About Running Out of Money? Don’t Read This

We know we shouldn’t take money from our 401(k) plans before we retire because we don’t have enough saved in the first place, and secondly, it raises the risk that we’ll run out of money in our later years.

But more of us are doing it anyway.

A report coming out this week says an increasing number of us are withdrawing money from our retirement accounts to pay the mortgage, to pay down credit card debt and for other non-retirement expenses, according to the Washington Post.

[Use our calculator to get your retirement savings on track]

More than one in four workers either withdraw money or take loans from a 401(k) and other retirement accounts, the Post says, citing the forthcoming data from the financial advisory firm HelloWallet. Either way, we’re pulling out about a quarter of the $293 billion that’s deposited into our accounts each year.

The 10 percent penalty for early withdrawals (for people younger than 59 1/2) takes a huge bite out of our plans’ balances, but that doesn’t appear to be halting the practice.

Taking loans from a 401(k) plan isn’t necessarily a better option. We’re taking out money so we’re missing out on growing our funds in a tax-free environment. Though we aim to pay it back, with interest, what happens if we run into financial trouble unexpectedly and we can’t? That happened to more than 17 percent of workers last year – they defaulted on their 401(k) loans at double the rate of those who took out loans before the financial crisis hit.

In these cases, the loans become a withdrawal, and we end up putting our retirement at risk because we may not be able to accumulate enough to live comfortably after we’ve left our jobs for good.

Financial experts say it makes sense to take a loan from a retirement account in an emergency and only if we have no other options. But for big-ticket purchases like a car, a kitchen renovation or a trip, borrowing money from our future is a bad idea.

Not all employers allow workers to take withdrawals. For those that do, the IRS permits penalty-free withdrawals under these circumstances:

  • You become totally disabled.
  • You are in debt for medical expenses that exceed 7.5 percent of your adjusted gross income.
  • You are required by court order to give the money to your divorced spouse, a child or a dependent.
  • You are permanently laid off, you are terminated or you quit in the year you turn 55, or later.
  • You are terminated or quit and have set up a payment schedule to withdraw money in equal amounts over the course of your life. (Once you begin taking this kind of distribution, you are required to continue for five years or until you reach age 59 1/2, whichever is longer.)

For most of us, our 401(k) plans and our Social Security income are pretty much what we’re counting on to finance our retirement years. Fewer of us have guaranteed pension plans to fall back on as companies continue to shift the burden of responsibility for an adequate retirement onto workers’ shoulders.

We’re worried because we understand that this precarious retirement system leaves us vulnerable. And that’s true even when we don’t tap our retirement funds while we’re still working.

A recent study didn’t do much to reassure us. It found that nearly one in two people (46 percent) die with either no financial assets or less than $10,000.

Most of those studied didn’t own a home (or gave up ownership later in life) and relied almost entirely on Social Security benefits for income, according to the analysis of households with people in their last years of life.

The bottom line: Save, save and save some more.

Photo credit: 401k 2013 via flickr.com