Millions of workers dipped into their retirement savings last year. It’s a big problem

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Looting your retirement plan could spell trouble down the line.

Key points

  • New data reveals that 18% of workers have taken money out of a pension plan in the past year.
  • Looting an IRA or 401(k) could have a host of adverse consequences, such as not having enough money in retirement and having to pay a penalty.

Workers are often told to save for retirement so that they have access to enough money to pay their bills later in life. And it’s a good idea to regularly contribute to an IRA or 401(k) plan, if your employer offers one.

But once the money lands in your retirement account, it’s very important that you keep it there. That way, you can ensure it’s accessible during your senior years, when you’re likely to need it the most.

Unfortunately, over the past year, a full 18% of workers have dipped into their retirement savings, according to Salary Finance’s fourth annual report. And it’s a decision to avoid for many reasons.

The dangers of withdrawing money from retirement savings

Any funds you withdraw from an IRA or 401(k) during your working years will not be available to you in retirement. And that alone is a problem.

But also, when you take money out of one of these plans, you’re not just withdrawing some of your long-term savings. You also take away the possibility of investing this money and turning it into a larger sum.

Let’s say your IRA normally offers an average annual return of 8% on your investments. (That’s a bit below the stock market average.) If you withdraw $5,000 20 years before retirement, you won’t just lose $5,000 later in life. On the contrary, you will lose more than $23,000 if you take into account the missed investment growth.

Also, most of the time when you withdraw money from an IRA or 401(k) before age 59.5, you are charged a 10% early withdrawal penalty on the amount you withdraw. So, let’s say you need $5,000 in a pinch to cover a home repair. Withdraw that money at age 45 and you’re looking at losing $500 of it right off the bat.

A better way to access cash

If you need cash on the fly and you have the equity in your home, borrowing against it might be a better option than raiding a retirement plan. You can take out a home equity loan and pay it off over time, for example, or apply for a HELOC (home equity line of credit) and access money when you need it.

If you don’t own a home or don’t have equity in a home, you can consider a personal loan if you need the money. If you have good credit, you may qualify for a relatively low interest rate on one of these loans.

Keep in mind that if you have a 401(k) plan, you may be able to borrow against it. In this case, you will repay yourself, not a lender.

But there is a danger in taking out a 401(k) loan. If you do not repay it on time, it is treated as an early withdrawal and the aforementioned penalty applies. Plus, you lose the chance to invest that money while it’s out of your account because you borrowed it.

Of course, the ideal way to meet a need for money is to dip into your savings account. But if you’ve gotten to the point where you’re considering plundering a retirement plan, that means you probably don’t have money in regular savings to access.

If so, work on building up an emergency fund as soon as possible. This way, when a need for money arises in the future, you won’t have to consider withdrawing from an early retirement plan – and face any undesirable consequences as a result.

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