I recently read an article discussing PwC’s 2017 Employee Financial Wellness Survey. This study found that more folks are taking early withdrawals from their 401(k) plans, particularly millennial and GenX employees. The most common reasons for the withdrawals, according to the survey, were unexpected expenses, medical bills, paying off credit cards, paying for education expenses, and buying a home. Here are three reasons why raiding your 401(k) is a bad idea.
You will have to pay a portion of what you withdraw for income taxes and penalties.
As mentioned in last week’s blog, when you make a withdrawal from your 401(k) plan, you have to pay income tax, both federal and state, on the total amount of the withdrawal. In addition, if you have not yet reached the age of 59½, you will be assessed a 10% penalty unless your withdrawal falls into one of the limited number of exceptions.
You are jeopardizing your future financial well-being.
By taking funds out of your 401(k) plan now, you are losing out on the power of compounding to increase your future nest egg. This could jeopardize your ability to retire when you want and/or maintain your same standard of living in retirement. Most Millennials and GenXers realize they probably won’t receive the same level of Social Security benefits that Baby Boomers are receiving. Some even think there may not be any Social Security benefits available to them at all. This makes it vitally important to not only regularly invest in your future retirement but to leave the funds in the account to allow them time to increase in value until you are ready to retire.
You could be jeopardizing the future of your children.
If you take withdrawals from your 401(k) plan for expenses now and are left with a shortfall in funds when you need to retire, you may be putting the burden on your children to provide for your needs. Many GenXers are already feeling the effects of being sandwiched between caring for their children and their parents. Leaving funds in your 401(k) plan until you retire will reduce the need for your children to experience the same sandwiching.
How to avoid a 401(k) raid
Rather than ending on that sad note, let’s finish up with two actions you could take to avoid having to use funds from your 401(k) plan for unexpected expenses or any of the other reasons listed above.
Create a spending plan and use it.
With a spending plan, you decide ahead of time how you are going to spend your income. It’s all up to you to decide how much you are going to put into savings for future purchases, how much you are going to spend on entertainment, food, groceries, and whatever else you want to spend your income on. That frees you to not worry about whether you are overspending because you just spend what you already decided you are going to spend.
Have an emergency fund for those unexpected expenses.
Starting with a $1,000 emergency fund will help avoid using your credit cards for those unexpected expenses like having the washing machine break down. Gradually increasing the emergency fund to three to six months of your basic living expenses with provide you with peace of mind so that you don’t have to raid your 401(k) plan.
If you have any questions, contact us at [email protected].Judith Ackland has more than 26 years of experience in accountancy and financial planning, including seventeen years as a CFO of a diverse business. She started Crystal Financial in 2010 to help a wide array of individuals, families, and business owners better understand their finances and how good financial management could help them achieve their goals. Judith has an MA in Professional Accountancy from the University of Nebraska at Lincoln as well as a Certified Public Accountant Certificate and a Certified Financial Planner designation.