Wednesday, December 17, 2014

Don't Tap Into That 401(k) Until Retirement

At the expense of their future selves, many people spend too much in the present and don't save and invest sufficiently for their future financial well being.

One example is that eligible individuals frequently don't even save and invest in available 401(k) employer match opportunities. And to make matters worse, many who do contribute withdraw funds prior to retirement.

Getting it almost right in the present and then undoing that right thing by ignoring the future won't result in a happy ending. So if you are currently doing the common sense thing by saving and investing in a 401(k), do yourself a big favor and find a way not to touch that money until retirement.

Combating a Flood of Early 401(k) Withdrawals has the story:

"One of the biggest problems with these accounts has nothing to do with how much we can put in. Instead, it’s the amount that so many people take out long before they retire.

Over a quarter of households that use one of these plans take out money for purposes other than retirement expenses at some point. In 2010, 9.3 percent of households who save in this way paid a penalty to take money out. . . . Millions of people are clearly not using 401(k) plans as retirement accounts at all, and it’s a threat to their financial health.

“It’s not a system of retirement accounts,” said Stephen P. Utkus, the director of retirement research at Vanguard. “In effect, they have become dual-purpose systems for retirement and short-term consumption needs.”

How did this happen? Early on in the history of these accounts, there was concern that if there wasn’t some way for people to get the money out, they wouldn’t deposit any in the first place. Now, account holders may be able to take what are known as hardship withdrawals if they’re in financial trouble. Moreover, job changers often choose to pull out some or all of the money and pay income tax on it plus a 10 percent penalty.
The breach tends to be especially big when people are between jobs. Earlier this year, Fidelity revealed that 35 percent of its participants took out part or all of the money in their workplace retirement plans when leaving a job in 2013. Among those from ages 20 to 39, 41 percent took the money.

The big question is why, and the answer is that leading plan administrators like Fidelity and Vanguard don’t know for sure. . . . “Some people see a withdrawal as an opportunity to pay off debt,” said Jeanne Thompson, a Fidelity vice president. “They don’t see the balance as being big enough to matter.”

Or their long-term retirement savings matter less when the 401(k) balance is dwarfed by their current loans. . . .

Another big reason that people pull their money: Their former employer makes them. The employers have the right to kick out former employees with small 401(k) balances, given the hassle of tracking small balances and the whereabouts of the people who leave them behind. According to Fidelity, among the plans that don’t have the kick-them-out rule, 35 percent of the people with less than $1,000 cashed out when they left a job. But at employers that do eject the low-balance account holders, 72 percent took the cash instead of rolling the money over into an individual retirement account. . . .

Account holder ignorance may also contribute to the decision to withdraw money. “There is a complete lack of understanding of the tax implications,” said . . . (the) chief behavioral economist at Allianz Global Investors, who has done pioneering research on getting people to save more. “And given that we’re generally myopic, I don’t think people understand the long-term implications in terms of what it would cost in terms of retirement.”

In fact, young adults who spend their balance today will lose part of it to taxes and penalties and would have seen that balance increase many times over."

Summing Up

Individuals contributing to a 401(k) should resist the temptation to withdraw any funds prior to retirement. It's simply too costly in many ways.

Early withdrawals often represent an expensive way to access money and always serve to undo much of the good work involved in saving and investing for the long term.

So when there's a need, do your best to find another source of funds for those 'emergencies' during your working years.

By so doing, your older self will thank you for what your younger self did.

That's my take.

Thanks. Bob.

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