The Retirement Hot Seat: To Tap or Not to Tap Your 401K?
A large and growing share of American workers are tapping their retirement savings accounts for non-retirement needs, raising questions about one of the most important savings vehicles for old age; The 401k Account.
As we all know, success for your 401k depends on workers consistently contributing to them and allowing the money to stay in place throughout their careers, allowing the investment returns to compound. Many earning high salaries do just that—but many others who have little savings elsewhere, tap their retirement money as a sort of “rainy day” fund—eroding its power for your retirement.
Right now one in four American workers with 401k and other retirement savings accounts use them to pay their current expenses. These withdrawals have drained nearly $293 billion that workers and employers deposit into the account annually, undermining an already shaky retirement foundation for millions of Americans. With cuts in Social Security and Medicare being eyed by Washington to rein in federal deficits, and traditional pensions declining, retirement savings experts say the cash drain from these accounts will have negative implications for future retirees.
“We think of the United States as a progressive leader among countries. However, typically thought of a first-world nation, is rapidly losing its standing if one considers the security and life-style of its average citizens after retiring from the work force,” said William Gale at the Washington-based Tax Policy Center.
The most common way Americans tap into their retirement funds is through loans, which have to be paid with interest. Those withdrawing money face stiff penalties. In most cases, they not only are saddled with a 10m percent federal tax penalty, but also pay income taxes. The costs are financially harmful to families even as money-managing firms reap massive fees for handling retirement accounts that are not used for retirement.
Using data from the Federal Reserve’s Survey of consumer Finances and the Survey of Income and Program Participation, done by the Census Bureau, the report indicated that 30 percent of households earning less than $50,000 a year had cashed out a retirement plan for a non-retirement purpose. Only 12 percent of households earning between $100,000 and $150,000 a year and 8 percent of those earning more than $150,000 a year have cashed out a retirement account.
Workers drawing on their retirement accounts put themselves at risk of descending into poverty when they retire—leaving them dependant on government programs like subsidized housing and food stamps. Nearly 6 million retirees were living at or near poverty in 2010, with that number expected to rise sharply over the coming decade after a long period of decline.
“The investment advice out there needs to recognize that a large share of participants is not going to use the money for retirement so they should not be exposed to risky investments. There is no investment [educator] in the country that would put workers in the stock market if they were told the money being invested was for short-term needs, Never.” said Gale.