It's a 401(k), Not a Piggy Bank ... So Don't Treat It Like One
With a piggy bank, you put money in and take it out. It's a fairly simple tool, and it's great for what it's used for. A 401(k), on the other hand, is a great tool to save for retirement. But increasingly, 401(k)s are being used as something they aren't -– piggy banks.
Recent studies show that Americans are increasingly pilfering from their 401(k) accounts. With the economy being the way it has been since the financial crisis, that's understandable on one level, but the choice can put your retirement plans on a slippery slope.
According to the IRS, $57 billion was withdrawn prematurely from 401(k) accounts in 2011 -- up 37 percent in inflation-adjusted dollars from 2003. You could argue that if a person needed the money to survive, then an early withdrawal from a 401(k), even with the tax penalty, is better than other options. That would be right -- to a point.
The most disconcerting number, in my opinion, is that younger individuals are withdrawing the most. According to a Fidelity (FNF) study, nearly 40 percent of workers between 20 and 39 are cashing out their 401(k) plans when they change jobs. There could be many reasons for this, but the Fidelity study points out that many don't see the need to roll over their old 401(k)s when the amount being considered is "only" several thousand dollars or a little more. Add that to those people who take out 401(k) loans to fund such things as real estate purchases, and it paints a worrisome picture.
The Real Purpose of a 401(k)
To a degree that it hasn't for decades, the burden of retirement planning now falls on individuals. Only about 30 percent of companies still provide pensions, and even among those, more firms are freezing them.
%VIRTUAL-article-sponsoredlinks%In light of that, your 401(k), with its tax-advantaged status, is likely going to be one of your best options for putting aside money for retirement. While there may be times where you need to take out loans for different purposes, simply cashing out a 401(k) should be avoided at all possible. This is especially the case if you switch jobs: When that happens, you will want to either roll over your 401(k) into your new plan or into a rollover IRA. Not only will this allow you to avoid losing money due to early withdrawal penalties, but it will also keep the power of compound growth on your side as you build up your retirement nest egg.
Saving for Retirement Is a Long Game
The rise in early 401(k) withdrawals reveals a broad lack of understanding about retirement planning. Saving for your old age is is a marathon, not a sprint -- one that takes decades to complete. By raiding your 401(k), you're only harming your future. Unless you plan on working until you're 80, it behooves you to leave your savings untouched so you can reach retirement relatively close to when you plan to.
When we're talking about amounts under $10,000, it can be easy to think that they'll mean nothing in the long run. But if you invest it wisely and let it stay in the market long-term, it can build on itself to and turn into serious money each month for you in retirement. (Don't believe it? Check out the first two slides in this article. The math is clear: Small Money + Time to Compound = Big Money)
Part of saving for retirement is making sure we're doing what's best with our 401(k) funds. If you're tempted to withdraw money from it early, ask yourself if raiding your savings now is the best decision for your long-term wealth. In most cases, it's not.
John Schmoll is the founder of Frugal Rules, a finance blog that regularly discusses investing, budgeting, and frugal living. John is a father, husband, and veteran of the financial services industry who's passionate about helping people find freedom through frugality. He also writes about wise ways to manage your money at WiseDollar.org.