The 2 Major Consequences of Tapping Into Retirement Early
Nearly 33% of Americans withdrew or borrowed money from an IRA or 401(k) during the pandemic, and nearly two-thirds (63%) used those retirement savings to cover basic living expenses.
In addition to the global health crisis, many Americans are really struggling financially. Where did those payments for living expenses go?
- 41% said to pay medical bills
- 32% said the money was used for home repairs
- 26% used the money for auto repairs
- 23% paid tuition
- 21% helped family members
While these may be necessities, tapping into retirement funds can be harmful.
What’s the Harm in Tapping Into Retirement Early?
You always hear that you shouldn’t tap into retirement early, but why is that?
One of the biggest advantages to retirement savings are the tax benefits later in life.
When you wait to tap into your retirement savings, you will still have to pay income tax on your withdrawals but you will also likely be in a different tax bracket, and thus your income tax will likely be lower.
Not only is each traditional 401(k) plan contribution tax-deductible, but the money also grows tax-deferred while it’s in the plan. You’ll put off paying income taxes on contributions and earnings until you take distributions which can be a huge benefit to keeping your retirement savings untouched (i.e. more money later!)
For example, when you withdraw before the age of 59 and a half, you will be subject to those income taxes and you’ll have an additional payment of 10% of whatever you withdraw.
Additionally, whatever you thought you had saved for later in life will likely be smaller due to the added 10% charge that you hadn’t originally accounted for. So no matter what, the saved funds you thought you had will be significantly smaller…
How Has the Pandemic Further Affected This?
There are now some exceptions to the rules. If you withdrew from your retirement early under the Coronavirus Aid, Relief, and Economic Security (CARES) Act between January 1 and December 30, 2020, you won’t be subject to the additional 10% charge.
However, you still will have a significant decrease in your retirement savings which means you could need to:
- Find a new job with a better retirement plan to save up what you took out
- Find a better paying job and/or a second job to replace some retirement savings (even if you do this, there are limits to the amount of money you can save in your 401(k) each year)
- Work later in life than you had planned
The Impact of Tapping Into Retirement Early
Due to the stimulus bill, you can re-contribute to your 401(k) plan through one or more payments made within the next three years. These contributions won’t be counted toward the usual 401(k) annual contribution limits.
That doesn’t solve the problem though for the people who won’t be able to make those same payments back in three years. Years of saving to their 401(k)s were destroyed within months…
Now, Americans have:
- Less money saved if another crisis were to occur (and we know that every year, 60% of Americans will face a financial shock of $2,000 or more)
- Portfolios that have been depleted from years of saving
- Financial stress that wreaks havoc on physical and mental health
- More time to stay in the workplace which could impact the incoming generation
A Solution Instead
Employers can save the day here. Employers that can offer employer-sponsored loan programs are one step ahead of their counterparts at providing their employees with financial stability.
Offering retirement plans is a great benefit which so many employees utilize, but there are a large number of employees who don’t have enough money to feel confident even participating in a 401(k) plan due to low savings.
However, if your employer offers a loan program, like TrueConnect, which does not require a credit score, you can trust that your loan and repayment process are safe.
If you’re interested in learning more about TrueConnect, our no-cost employer-sponsored loan program that does not require a credit score, share this ondemand demo with your benefits director.
For more information on the Coronavirus Tax Relief, please click here.