Americans who are feeling the pinch of high inflation are raiding their retirement savings, an ominous sign for a country that is already struggling to save for retirement.
According to Vanguard Group, which tracks 5 million savers, the share of workers withdrawing cash from their employer retirement plans as new loans, non-hardship withdrawals, and hardship withdrawals has increased this year.
People can borrow up to $50,000 from their 401(k) plans as a loan to be repaid to their account, or they can take a non-hardship withdrawal while still working for their company. However, if they withdraw money without a valid and serious financial need (a hardship withdrawal), they will almost certainly face a 10% withdrawal penalty, and the IRS will almost certainly withhold 20% of the amount withdrawn for taxes.
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According to Vanguard, the percentage of people taking hardship withdrawals from their 401(k) retirement plans reached 0.5% in October, the highest level since 2004, when the company began tracking the data.
Hardship withdrawals are frequently the last resort for people in need of money, and this could indicate how severe consumers’ financial distress is. According to IRS rules, they can only be used to meet “immediate and severe financial need,” and they are subject to income taxes as well as a 10% early withdrawal penalty. Taxpayers in the 22% bracket, for example, would owe $1,000 in penalties plus $2,200 in income tax on a $10,000 hardship withdrawal.
“We know that inflation has eroded employees’ purchasing power and is likely straining family budgets,” said Tom Armstrong, vice president of customer analytics and insight at Voya Financial, a retirement, investment, and insurance firm.
In the absence of emergency savings, retirement nest eggs are frequently used as a fallback plan. According to Voya data, employees who do not have adequate emergency savings are 13 times more likely to take a hardship withdrawal and three times more likely to take a loan from their retirement plan.
When strapped for cash, is dipping into retirement savings a good plan?
Not if you can avoid it.
“While we recognise that in some cases, individuals may be forced to tap their retirement accounts, it’s important to remember that people work hard for their retirement savings and should only use them as a last resort,” Armstrong said.
A hardship withdrawal can provide you with immediate access to cash, but it has significant financial consequences. There are not only the immediate taxes and penalties to consider, but also the long-term retirement implications.
You may be unable to contribute to your workplace retirement plan for six months or more, and you may lose the compounding growth of your investments, according to Nilay Gandhi, senior wealth adviser at Vanguard. Compounding increases your money exponentially because you earn a return on both your initial investment and previous returns on that investment.
Is it ever appropriate to withdraw from your retirement fund? Here are three instances where it makes sense.
However, if you must draw on your retirement savings, Gandhi suggests that you consider the following two options first:
- A loan from your 401(k) plan (k). If your plan allows loans, you must repay them to your retirement account so that you are not losing money. The money is also not taxed if the loan meets the requirements and the repayment schedule is followed, according to the IRS. Loans are limited to 50% of the vested account balance or $50,000, whichever is less, unless the balance is less than $10,000 in half. Furthermore, “we would caution that those funds are taxed and penalised if you are unable to repay the loan and come due if you leave employment,” Armstrong said.
Withdraw funds from your Roth IRA. Because you contribute to a Roth IRA with money that has already been taxed, qualified withdrawals are tax-free and penalty-free at any age.
How can I get cash without taking money out of my retirement savings?
Before turning to retirement savings for cash, consider some of the following options first:
- Savings. Unexpected expenses are precisely what emergency savings are intended to cover. So, if you have any, this should be your first port of call.
- Loan from a bank. A personal loan may be a good option if you have a one-time expense and good enough credit to qualify for a low, fixed-interest rate.
If you own a home, you can get a home equity line of credit, or HELOC. You use your home as collateral to obtain a credit line from which you can borrow money. You only pay interest on what you withdraw, and the interest may be tax-deductible if the funds are used to improve your home. However, keep in mind that they frequently charge fees and have variable interest rates, and the Federal Reserve is currently on an aggressive rate hike cycle to slow inflation.
- Additional effort. “If you’re able to take on part-time work. “Many companies are still looking for people at competitive hourly rates,” Gandhi said. Nowadays, there are a variety of side hustles that people can do from home, such as selling goods on eBay or Etsy.
- Purchase credit cards with no interest. “You can use one of these special offers to cross the bridge for 12 to 18 months,” Gandhi said.
- Standard brokerage accounts. Even though most investments are down this year, there may be a few winners you can cash in on. The money will be subject to capital gains tax, but if you have any losses, you may be able to sell them and offset your gains to reduce your tax bill.
- Flexible and health savings accounts, if you need money to cover health-care expenses. * Borrowing from family and friends.