Retirement is one of the biggest goals you can save for throughout your lifetime. Despite this, lack of savings is a sticking point for many Americans. All to often, they are behind. To put it in perspective, Federal Reserve data shows that about 25% of non-retirees have no form of savings set aside for retirement. If you’re among those who have saved with an employer-sponsored plan or other investment, leave retirement savings alone. We explore why in this article.
While Americans generally save money as they grow older, large portions of the population still neglect it. For example, the Fed found that 41% of those aged 18-29, 46% of 30-49 year-olds, and 26% of 50+ year-old Americans had no savings set aside for retirement.
Furthermore, Federal data reveals that 5% of non-retirees borrowed from their retirement account, while 4% permanently took out money (and 1% did both). Of those non-retirees, 73% view their retirements savings as off track or lagging behind. While a savings gap is an issue, the fact that Americans are withdrawing from their retirement accounts is a major problem.
Leave Retirement Savings Alone – Here’s Why
Borrowing against retirement savings warrants major penalties and stymies growth considerably. but still, many Americans consider drawing from retirement accounts when financial needs arise. Taking a distribution from a retirement plan may not be the best option. It may be better to leave retirement savings alone.
If you’ve got a financial emergency, Shanna Tingom of Heritage Financial Strategies says, “Call your financial advisor to review your account. Discuss your financial goals with them. There may be other options besides withdrawing funds from retirement savings.”
You May Pay Taxes on Withdrawn Funds
The majority of retirement savings are contributed to accounts on a pre-tax basis. This means income taxes are deferred on the contribution amounts Instead, they are assessed when funds are withdrawn from a retirement savings plan. When pre-tax contributions are withdrawn, they are taxed at current income rates. The tax burden you pay for taking a distribution to cover a financial emergency or another unmet need eats away at the amount you receive from the start.
Beware the 10% Early Withdrawal Penalty
On top of an income tax, retirement savings that are taken out early incur a major penalty. The IRS established specific rules for retirement accounts to encourage long-term savings, while discouraging anyone from dipping into retirement funds.
Therefore, early distributions – those taken before age 59 ½ - result in a 10% tax penalty which is paid in addition to the income taxes owed on the amount. This penalty, which applies to both individual IRAs and employer-sponsored retirement plans, decreases the amount of the distribution and creates a tax liability.
Other Penalty Fees Can Cost You
Putting tax burdens aside, distributions from a retirement savings account can incur additional fees (yes, more penalties!). Taking a withdrawal from a 401(k) or an IRA may mean paying a penalty or charge that is assessed by the custodian of the account. Depending on the company that manages your retirement savings account, the fee could be a flat charge or a percentage-based charge based on the distribution amount. These added expenses eat away at the amount you ultimately receive from the withdrawal.
Long-Term Account Growth Is Stymied
Although taxes and fees for distributions are discouraging and costly, the most significant issue with taking out retirement savings for non-retirement expenses revolves around growth potential. Americans are encouraged to save toward long-term retirement goals as early as possible, and doing so provides a strong foundation for retirement planning in the future. The longer you leave retirement savings alone, the more it can grow via compounding interest.
Withdrawing retirement funds drastically stymies growth potential. A distribution from a retirement plan early on in life reduces the ability to benefit from compounding interest for several years. On the other hand, a withdrawal closer to retirement may leave little time for making up the decrease in savings. In either case, distributions from retirement accounts seriously impede the lifetime growth potential of your savings and investments.
Final Word: Leave Retirement Savings Alone
There are circumstances where tapping into retirement savings may seem like the only viable option. Paying for unexpected expenses or a large bill may not be possible with savings or other assets. Although withdrawals from retirement savings seem like an easy solution, the cost of doing so far exceeds the immediate benefit you may gain. Rather than withdrawing funds, leave retirement savings alone and make an appointment with your financial advisor to discuss options.
Andrew is a Content Associate for LendEDU – a website that helps consumers, homeowners, small business owners, and more with their finances. When he’s not working, you can find Andrew hiking or hanging with his cats Colby & Tobi.
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