More Americans are tapping into retirement savings to cover short-term and emergency expenses than had to a decade ago, with young people especially finding themselves in this bind. Over a quarter of millennials have taken a hardship withdrawal from a 401(k) or other retirement account in the past decade, and over a quarter have taken a loan.
The number of people taking out hardship withdrawals or loans from their retirement accounts has ticked up steadily since 2009, according to the latest National Financial Capability Study from FINRA, the privately operated Financial Industry Regulatory Authority. Since the financial crisis, over twice as many 18-to-34 year olds reported dipping into their 401(k)s.
The share of 34-to-54 year olds reaching into their retirements funds has remained fairly stable, while slightly fewer people over 55 are doing so than did in 2009.
"The increase for the 18-to-34 year old group from 2009 to 2018, in terms of tapping into their retirement savings, either via loans or withdrawals, is a really troubling finding," says Gary Mottola, FINRA's research director.
The 2018 edition of the National Financial Capability Study, which FINRA releases every three years, concluded that although financial well-being has improved for virtually all demographic groups since the financial crisis, it has improved more slowly for young people and for racial minorities, especially African-Americans.
"You definitely see that younger Americans, people who don't have a college degree, African-Americans, and those with lower incomes are not experiencing the benefits of the economic growth," says Gerri Walsh, president of FINRA's Investor Education Foundation.
Walsh and Mottola both point to student loans as a significant factor. Rising tuition costs have led millennials to take out more, and bigger, student loans than their parents and grandparents had to at their age.
"The fact that so many of the younger demographics are taking on student debt means that, effectively, they will be leaving a negative inheritance to their families," says Walsh.
"I wish I could say it is merely an issue of financial education and responsibility, but that is not enough of a factor," says Erika Safran, a certified financial planner and the founder of Safran Wealth Advisors. "Many younger folks have more debt (in terms of school loans) and less income adjusted basis than their parents did at their age." So when an emergency strikes, younger people have less money on hand and fewer options except to raid retirement accounts.
While every 401(k) plan is different, many plans allow you to take out a hardship withdrawal, which lets you take out money to cover large, unexpected expenses, like medical bills or an emergency payment to avoid being evicted from your home or foreclosed on. That money is exempt from the usual 10% penalty on early 401(k) withdrawals.
Still, whatever you withdraw can be taxed as income for that year, and every dollar you remove is a dollar less that's earning interest for your retirement.
A retirement loan is a bit different. While you are loaning money to yourself, your retirement account is still bound by the terms set by your employer. So, if you take out a loan from your 401(k), you have to pay it back, with interest. That means you're making loan payments to yourself, after taxes, that you wouldn't be paying if the money was still growing in your retirement account.
For all of these reasons, financial advisors urge people to only draw upon their retirement savings as a last resort. Here's how you can prepare yourself for emergencies so they're less likely to wreak havoc on your future.
Forty-six percent of Americans do not have three months' worth of emergency funds, according to the 2018 FINRA study. The study does show, though, that more people (46%) have that kind of cushion than did in 2009 (35%).
If you can, Safran suggests setting aside a fixed amount of your paycheck each month to go into an emergency fund. Ideally, you want to have money for three-to-six months of expenses in cash, like in a checking, savings, or money market account, rather than in the stock market. High-yield online savings accounts are a great option, too.
While investments can be great for building wealth in the long term, the market can get bumpy in the short term, and you don't want your emergency fund to lose value on the same day you have to, say, take your child to the emergency room.
Even if you can't devote a lot of money to a rainy day fund, putting aside a small amount is still better than nothing.
"Get into the habit of moving $50 a month into your money market fund. You can get in the habit of $100 and have it set up automatically. Because I think the key is to create a discipline and, if you're not all that disciplined, it's best to have a system," Safran says. "It can be small, but it has to be consistent, because it's the consistency that's going to reward you."
Knowing how much money to save and how to organize that saving is vital, but knowing what to do with the money you can't save is also important.
One really good budgeting method is the 50/30/20 system, popularized by Senator and presidential candidate Elizabeth Warren in her 2005 book "All Your Worth: The Ultimate Lifetime Money Plan." In this system, you devote half of your take home pay to living expenses, 20% to savings, investments, and loan repayments, and keep the remaining 30% for discretionary spending (i.e., all the fun things you enjoy that also happen to cost money).
A reverse budgeting strategy, in which you budget whatever is left over from your paycheck after paying your living expenses and setting aside money for savings, can also be helpful.
Economic realities have made the very idea of retirement seem impossible for a growing number of people, but with proper planning, you can make saving for it a little less difficult, and work towards building the financial future you want.
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