Sometimes, life throws financial surprises at us, and when that happens, emergency savings can come in very handy. But if you don't have emergency savings, you may be inclined to tap another cash source -- your retirement account.
If you go that route, you're not alone. A good 34% of workers have taken a loan or early withdrawal from a retirement plan, according to the 21st Annual Transamerica Retirement Survey. That includes hardship withdrawals from a 401(k). But while you may have no choice but to tap your retirement savings for a true emergency or hardship, here's why it's generally not a good idea to raid that account early.
Don't leave yourself short for your senior years
The benefits you receive from Social Security will likely replace about 40% of your pre-retirement income. Meanwhile, most seniors need about twice that much money to cover their expenses without stress.
The more money you remove from your 401(k) or IRA ahead of retirement, the less you'll have available once your time in the workforce comes to an end -- it's that simple. And so taking an early withdrawal from your long-term savings is something best avoided.
Remember, you might think that removing $10,000 from your retirement account is no big deal. But if you take that withdrawal when you're 40 and you're not retiring until age 70, and your investments in your account generate an average annual 7% return, you'll actually end up having lost out on about $76,000 after all is said and done. That's a much more significant loss.
Now during the coronavirus pandemic, a lot of people were forced to tap their savings early to make ends meet. That was, to be clear, an extreme situation, and such withdrawals were more than justifiable.
But there's a difference between taking an early 401(k) or IRA withdrawal due to an emergency and taking one for non-urgent matters. And you shouldn't raid your retirement account to pay for home renovations or do anything that isn't absolutely pressing.
The same applies to borrowing from your retirement savings. Though there's no such thing as an IRA loan, 401(k) loans do exist. However, there are risks involved with 401(k) loans. If you don't repay your loan on time, it will be treated as an early withdrawal from your account if you're not yet 59 1/2. That could leave you on the hook for a costly 10% penalty on the sum you remove. And then if you don't repay that loan at all, you'll be short the money later in life.
Don't make a big mistake
Many seniors end up relying heavily on their savings to pay their bills. And given that Social Security benefits may be cut in the future, shorting yourself on savings is a dangerous move.
It pays to do whatever you can to leave your retirement savings alone, and look at other ways to scrounge up cash when you need it. That could mean getting a second job or selling items you can command decent cash for.
Finally, if you do end up having to take a withdrawal from your retirement plan, do your best to put that money back afterward. The more money you're able to carry with you into retirement, the better off you'll be.
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