Millions of Americans use 401(k) plans to save for retirement. With companies offering fewer pensions and Social Security replacing only 40% of pre-retirement income; 401(k)s play a key role in financing our golden years. Despite the significance of the savings plan, MassMutual says workers are making costly, life-altering mistakes. Josh Mermelstein, head of retirement readiness solutions at MassMutual, shared three 401(k) behaviors to be avoided:
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Say no to loans
Do you need money to pay for a vacation? What about that new car you’ve been dreaming about? Mermelstein says your 401(k) is not an optimal place to take out funds – especially for non-emergencies. He says the withdrawal you take out at age 40 may ultimately mean working an extra five years, retiring with 20% less, or potentially both. Lack of sufficient savings may also force workers to stay on the job past the traditional retirement age of 65. If you don’t repay your loan, your employer will treat the loan balance as a distribution. That means you could be hit with an 10% early withdrawal penalty and income taxes, if you're under age 59 1/2. If you change employers, you will also be required to pay the loan back in full.
Understanding hardship withdrawals
Financial emergencies can happen at any time. You may have a medical emergency not covered by your insurance. You could be facing an eviction or foreclosure from your residence. That’s where hardship withdrawals come in. The IRS says a hardship distribution can only be made if there is an immediate financial need. It must also be limited to the amount necessary to satisfy that financial need. While your savings plan may offer hardship withdrawals, Mermelstein says you shouldn’t look at your 401(k) as a piggy bank. Only tap into your retirement fund as a last resort. He says that's why it's important to have an emergency fund for unexpected expenses.
Never suspend contributions
Companies typically suspend salary deferrals for six months after a worker withdraws savings. Salary deferrals are the contributions you regularly make to your 401(k) plan on a pretax basis. Mermelstein says it's a big mistake to stop deferrals on your own because you want to catch up on bills or generate more income. After taking out loans, some workers also choose to stop funding their retirement plan. He says months can turn in years and eventually you will lose out on many years of earnings. MassMutual says suspending 401(k) plan contributions, dipping into retirement savings early – or both – is projected to reduce workers’ retirement savings on average by 14%. Younger workers are expected to see a bigger impact from those behaviors. "People are unknowingly making their retirement goals harder," says Mermelstein. "A 35- to 40-year-old may now be missing 20 to 25 years of compounding. That really adds up and can impact their level of income in retirement."
Linda Bell joined FOX Business Network in September 2014 as an assignment editor after more than a decade at Bloomberg. She is an award-winning journalist/writer of business content. You can follow her on Twitter: @lindanbell