Why You Shouldn't Use Your Retirement Account As a Piggy Bank
August 4, 2014 | Your Finances
By Lisa Wirthman
Looking for help in lean times, record numbers of Americans are using their retirement accounts as piggy banks. But it’s not a great idea, financial experts say.
In 2011, the Internal Revenue Service (IRS) collected more than $5 billion in penalties from taxpayers who took premature withdrawals from their tax-deferred retirement accounts.
A number of Americans used to raid their home equity as a source of cash, but the 2008 housing collapse revealed the financial dangers of that strategy. Between 2007 and 2013, the amount of outstanding home equity loans dropped 38 percent to a low of $704 billion, according to Federal Reserve data. So, the alternative for some is to rob their retirement accounts.
More than a quarter of 401(k) participants are using their 401(k) savings for non-retirement needs, according to a report from HelloWallet in January of 2013. And 75 percent say they breached their retirement savings because of basic money management problems.
Yet nearly half of non-retired Americans are counting on their retirement accounts as a major source of retirement income, according to a recent Gallup survey.
"One of the biggest dangers in borrowing from retirement accounts is that many people stop investing in their retirement while they’re paying off their loans," said Scott Ashline, a Northwestern Mutual wealth management advisor in San Diego. “The sad reality is that it never gets replenished,” he said.
A person who borrows $20,000 from a retirement account, for example, will likely pay taxes and penalties for the early withdrawal. In a double whammy, he or she also may stop contributing additional funds to that retirement account until the loan is repaid, resulting in even more lost retirement savings down the line.
The difference in savings “can be hundreds of thousands of dollars,” Ashline said. “There’s a lot of long-time planning that gets sacrificed for short-term things.” Buying a new car or taking a vacation, for example, should never be paid for with dollars already set aside for retirement.
To avoid taking early withdrawals from retirement accounts, Ashline recommends setting up three different types of savings: a short-term fund in an account that can be accessed in three to five days without penalty; mid-term savings for bigger expenses such as education; and more aggressive long-term savings for retirement. “It’s not just about saving every penny for when you turn 65,” he said.
People who need to make emergency withdrawals can take them from short-term savings and avoid harming their long-term retirement funds.
For those who don’t have these three different savings types, Ashline advises clients to at least maintain a “rainy day” cash fund to tap into before touching retirement accounts.
"While the recession certainly changed people’s behavior regarding money, the silver lining may be that people now seem to place a greater emphasis on the overall need to save," Ashline said. “I think the one good thing the recession did is make people get real about their planning.”
Lisa Wirthman is a freelance journalist who writes about business, sustainability, public policy, and women’s issues. Her work has been published in The Atlantic, USA Today, U.S. News & World Report, Fast Company, Investor’s Business Daily, the Denver Post and the Denver Business Journal.
Originally published on Northwestern MutualVoice on Forbes.com.