What’s worse than not being able to make your mortgage payments? How about tapping into retirement savings to make ends meet? National Public Radio’s Morning Edition ran a story on Friday about the growing number of people making “hardship withdrawals” from their retirement plans. From the story:
“It’s a terrible choice on so many levels, because we shouldn’t be messing with our futures for the present,” says Jane King, a financial planner who serves as president of Fairfield Financial Advisors in Wellesley, Mass. For the first time in her career, she’s been getting calls about hardship withdrawals. King blames the housing market. She says until now, if anyone had surprise expenses, they’d normally take out a home equity loan.
“People had wiggle room by borrowing on their houses, and it just isn’t there anymore,” King says. “So the 401(k) or the retirement plan has become maybe the next best thing.”
Alicia Munnell, director of the Center for Retirement Research at Boston College, says the real price of cashing out retirement savings early is not the penalty, but the loss of the decades of interest and growth that those savings would have earned.
If drawing on retirement savings to salvage present-day personal finances is so bad, why are people doing it? Because the future is “amorphous”, says Ashley Kennedy, a struggling homeowner who was interviewed for the story. What matters most to Ashley right now are the looming monthly payments.
Why is raiding your 401(k) to pay current bills a bad idea?
- If you take an early withdrawal from your 401(k), you not only have to pay income tax, but also a 10% penalty.
- Worse, when you spend your savings, you’re sacrificing the compound growth that might have achieved in the decades to come.
- After a hardship withdrawal, most employers won’t let you make a tax-deferred contribution to your 401(k) for at least six months.
Some experts say that if you’re really desperate to use the money in your 401(k), you’re better off taking a loan from the account than making a permanent withdrawal. You’ll lose potential earnings while the money is out of the account, but you won’t be subject to taxes or penalties. But even this isn’t a good idea, and should only be used if all other options have failed.
Don’t compound a bad situation by making another poor choice. Your retirement savings are a safety net for the future, not for the present.
[NPR's Morning Edition: Tapping 401(k) now may cause financial pain later, via Matildaben]
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