Why you shouldn’t borrow or withdraw from your retirement fund
Investing enough for retirement is a challenge. Unfortunately, some people end up complicating the task by making a costly mistake.
It is helpful to understand the risks of this common mistake so that you can avoid it if possible. In doing so, you will maximize the chances of ending up with the funds you need to enjoy your later years.
Will you be putting your retirement security at risk by making this financial gesture?
The big financial mistake many Americans make when it comes to saving for retirement is looting their investment accounts.
According to a recent study by the TransAmerica Center for Retirement Studies, 34% of workers accessed their retirement funds earlier. They did this by taking a 401 (k) loan, early withdrawal, or hardship withdrawal. The study showed that 25% borrowed money from their retirement accounts and 25% made an early withdrawal or withdrawal for hardship. Figures total over 34% as many workers took out loans and made withdrawals.
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Early withdrawals consist of withdrawing money from a tax-advantaged retirement account without falling into one of the exceptions permitted by law for early withdrawals without penalty and thereby incurring a penalty of 10%. Withdrawals for hardship are made before retirement age, but for a valid reason, so the 10% penalty is avoided. And the loans involve borrowing on a 401 (k) plan or similar account that authorizes the loans and paying the money back to yourself.
Full-time workers are in fact Following more likely to have withdrawn money from retirement accounts than part-time workers, with 36% of people working full-time indicating that they had drawn on their savings compared to only 22% of part-time workers. This could be explained by the fact that business accounts such as 401 (k) generally allow loans, unlike individual accounts such as IRAs.
Why is withdrawing money from a retirement account such a big mistake?
Withdrawing money from a retirement plan early can seem like an acceptable financial choice, especially if you are borrowing from yourself with the intention of paying it back. After all, the money is there. And if you are facing short-term difficulties, you might think that it is better to use it than to borrow to meet your current needs.
But there are several reasons why early withdrawals can be a big deal.
First of all, if you are hit with early withdrawal penalties, you are giving away a huge chunk of your money for nothing. You must also pay taxes at your regular tax rate on the funds withdrawn. Due to taxes and penalties, you might end up only being able to use a fraction of the amount you withdraw. If you’ve withdrawn $ 10,000, face a 10% penalty, and are in the 22% tax bracket, you could end up with less than $ 7,000 in usable after-tax funds.
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You’re also losing any returns you would have earned – and that can come at a huge cost over time. If you withdraw $ 10,000 30 years before retirement and don’t put it back, you aren’t reducing your final account balance by $ 10,000. You could end up with as much as $ 101,985 less by losing the returns that $ 10,000 would have earned over three decades (assuming an average annual return of 8%).
If you take out a loan instead of a withdrawal, you avoid penalties and the loss of decades of return – in theory, as long as you hand over the money. But you may not get the funds back into your account. The interest you pay yourself could also be much lower than the returns you would have earned over the life of the loan. And your account balance could end up being a lot smaller if you happened to borrow at an inconvenient time and miss some big stock market rallies.
Ultimately, once you’ve put your money in a retirement account, it’s best to do everything you can to keep it invested if you want to maximize the chances of ending up with the nest egg you need. So, unless you have no other choice, avoid making the mistake of looting your retirement accounts before you are ready to rely on them as a senior.
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