Here’s why 44 percent of Americans tap their retirement savings early

Setting aside money in a 401k can be a smart way to save for retirement. Accessing your retirement account before you reach 59 and a half is never ideal, as you could face steep tax penalties that will take a big bite out of any withdrawal you might make.

However, life has a way of hitting you with unexpected circumstances, and some people might think they have little choice but to take the hit and use their retirement savings for something they weren’t expecting.

But what types of unexpected costs are forcing people to pay a penalty to access their retirement savings early? And are there better financial solutions to pay for unexpected expenses?

GOBankingRates surveyed nearly 2,000 people who have made early withdrawals from their retirement funds to find out why they opted to tap into their nest egg earlier than expected.

RELATED: Best and worst states for retirement 2018

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1. Florida – You knew it had to be high on the list, didn't you? In terms of affordability, Florida topped the list while it placed fifth in terms of quality of life, overcoming its 20th-ranked healthcare rating.

2. Colorado – Ranked second in healthcare while quality of life came in 8th place, Colorado is constrained by its 23rd-place ranking in affordability.

3. South Dakota – The home of Mount Rushmore is the second most affordable state and ranked sixth when it came to healthcare, but can't break the top half in quality of life (ranked 32nd).
4. Iowa – Not typically thought of as a retirement destination, Iowa has decent rankings across the board (9th in healthcare, 11th in quality of life and 26th in affordability).

5. Virginia – Quality of life ranks well in Virginia (9th) while affordability and healthcare rankings are above average (18th and 21st respectively).

The next five desirable retirement states after Virginia are, in order, Wyoming, New Hampshire, Idaho, Utah, and Arizona.

What about the five states with the worst rankings? In descending order, they are:

46. Arkansas – Dead last in quality of life and 45th in healthcare, Arkansas is pulled up by its 20th-place showing in affordability.

47. Mississippi – The same principle applies to Mississippi, but even more so. The state is 49thin quality of life and last in healthcare, but it ranks 10th in affordability.
48. Rhode Island – Healthcare is above average (22nd), but quality of life and affordability are poor at 46th and 48th place, respectively.
49. New Jersey – The least affordable state in the union also has below average rankings in quality of life (28th) and healthcare (33rd).
50. Kentucky – Kentucky ranks 47th in both quality of life and healthcare and only 38th in affordability, earning the Bluegrass State WalletHub's least desirable retirement state ranking for 2018.
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Read on to learn why people dip into their retirement savings early, and what better alternatives might exist.

44% of Americans Tap Retirement Savings Early to Pay Off Debts and Bills

The GOBankingRates survey targeted 1,972 people who answered that they had withdrawn at least some of their retirement savings early.

They were then asked the question, “What’s the main reason you tapped into your retirement savings early?” and could choose from five possible answers:

  • To pay for a financial emergency
  • To pay for higher education
  • To pay for medical expenses/healthcare
  • To pay off debt and/or bills
  • To purchase a home

The most common answer by a wide margin is paying off debt or bills at 43.99 percent of those polled, with more than twice as many responses as the next most common answers.

The second- and third-most common responses are paying for a financial emergency and medical expenses at 21.72 percent and 21.66 percent of responses respectively, with the two responses garnering remarkably similar response rates. Bringing up the rear are purchasing a home at just 9.36 percent of answers and paying for higher education at a mere 3.27 percent of responses.

It’s not surprising that paying down debt is such a significant reason for dipping into retirement. The same core principle that fuels the growth of your retirement savings — compounding interest — can also make the cost of carrying debt over time crippling to your efforts to save.

RELATED: US cities where $1M will last you the longest in retirement

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10. San Antonio, Texas:

$1 million will last 23.15 years

9. Omaha, Nebraska: 

$1 million will last 23.60 years

8. Louisville, Kentucky: 

$1 million will last 23.68 years

7. Indianapolis, Indiana:

$1 million will last 23.73 years

6. Columbus, Ohio: 

$1 million will last 24.07 years

5. Memphis, Tennessee:

$1 million will last 24.23 years

4. Tulsa, Oklahoma: 

$1 million will last 24.31 years

3. Austin, Texas:

$1 million will last 24.53 years

2. Oklahoma City:

$1 million will last 24.58 years

1. Houston:

$1 million will last 25.96 years

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However, there are other options besides dipping into retirement accounts. For example, respondents could use a personal loan to consolidate high-interest debt instead. That way, they can avoid the taxes and penalties associated with early 401k or IRA withdrawals, and pay off their expense with a fixed monthly payment at an amount and loan length that works for them.

“It is important to explore your financing options before choosing which way to pay off debt,” said Dan Matysik, vice president of Discover Personal Loans. “A personal loan is appealing because it can save people money on higher-interest debt while also simplifying their finances with one fixed monthly payment. And if you use a lender like Discover, there are no origination fees or closing costs.”

Younger Savers Tap Retirement for Emergencies; Older Savers Use It for Healthcare

The reasons that drive people to make early withdrawals from their retirement accounts vary across age groups.

For example, early withdrawals for medical expenses increases significantly with age, with only 15.54 percent of those ages 45 to 54 giving that response, climbing to 23.06 percent for ages 55 to 64 and reaching 25.60 percent for ages 65 and older. Generally speaking, medical expenses increase with age, so the older you get, the more likely it is that you’ll have to deal with a major medical expense at some point in your life.

If you don’t want to withdraw money from your retirement account, there are other options you can consider, such as personal loans. In fact, major medical expenses are a common reason people take out personal loans. The 2017 Discover Personal Loans Survey found that of those surveyed, 26 percent would most likely use a personal loan for a major medical expense.

Higher education costs trended in the opposite direction, with the likelihood that people had made early withdrawals for that reason decreasing with age. Some 5.12 percent of those age 45 to 54 tapped their retirement savings early to pay for higher education, falling to 2.84 percent among adults age 55 to 64 and then 2.08 percent for those who are 65 and older.

 

That could reflect the rising costs of a college education in America, which have more than doubled since the late 1990s. The 65-and-over group was likely paying tuition with an early withdrawal either for themselves or their children.

A similar explanation could explain why the 45-to-54 age bracket is an outlier for the “to purchase a home” answer. The two older groups selected that option at 8.69 percent and 8.96 percent, but the youngest of the three is almost 20 percent higher at 10.6 percent.

This could reflect rising home prices outpacing inflation by a wide margin. Home purchases by younger generations are more likely to have taken place at a time when costs were much higher and down payments were harder to come by than those who are over 65.

Here’s a complete look at how each age group responded to the question, “What’s the main reason you tapped into your retirement savings early?”

AgeTo pay for a financial emergency To pay for higher educationTo pay for medical expenses/healthcareTo pay off debt and/or billsTo purchase a home
45 to 5424.86%5.12%15.54%43.88%10.60%
55 to 6424.64%2.84%23.06%40.76%8.69%
65 and over16.00%2.08%25.60%47.36%8.96%

Men Are More Likely to Use Retirement Savings to Buy a Home

Breaking the results down by gender also reveals some curious insights into why different circumstances might lead people to feel the need to bite the bullet and pay a penalty to use their retirement savings early.

Men and women have nearly identical response rates for answers “to pay for higher education” and “to pay for a financial emergency.” However, women are more likely to use their retirement savings for medical expenses, with a response rate of 22.94 percent of women versus 20.26 percent of men.

Men are significantly more likely to use retirement savings to purchase a home, with a rate of 11.64 percent of responses versus 7.29 percent of women.

Here’s a more in-depth look at how each gender responded to the survey:

What’s the main reason you tapped into your retirement savings early?To pay for a financial emergency (i.e. job loss)To pay for higher educationTo pay for medical expenses/healthcareTo pay off debt and/or billsTo purchase a home
Female21.78%3.17%22.94%44.82%7.29%
Male21.65%3.38%20.26%43.07%11.64%

When Should You Tap Retirement Savings?

So, when is the right time to withdraw from your retirement savings? In a word: retirement. Or, at the very least, after the age of 59 and a half.

Retirement accounts are structured to help the average person avoid taxes when building a nest egg. So, the IRS punishes those people who pull their cash out before they reach age 59 and a half. Early withdrawals from your IRA or 401k are taxed as normal income plus an additional 10 percent penalty on top. When you consider that, a big withdrawal might bump you up a tax bracket even before the penalty, and the costs can be high — upwards of a third or more of the money you’re trying to access.

There are a number of “hardship exemptions” that the IRS will waive the 10 percent penalty for, including $10,000 for a down payment for first-time homebuyers, medical emergencies, higher education costs and even certain financial emergencies. But even in those cases, you’re still paying normal income taxes on your withdrawal, and you miss the chance to let that money grow through investments.

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Make a Commitment to Save for Retirement

If saving for retirement isn’t a priority for you, consider this: If you’re struggling to get by now on a small paycheck, how will you get by in retirement without savings and no paycheck? You don’t want to retire broke and live on Social Security benefits alone.

“It can certainly be challenging to build up a good-sized nest egg, but it will certainly be impossible if you never try,” said Belinda Rosenblum, a certified public accountant and president of Own Your Money. “It all starts with a commitment.”

To ensure you follow through on your commitment to saving, let your family or friends know about your financial goals, said Polly Scott, spokeswoman for the 2017 National Retirement Security Week promoted by the National Association of Government Defined Contribution Administrators.

“If you talk about it … you’re more likely to do it,” she said.

Know Your Number

You might be asking yourself, “How much do I need to retire? Do I really need to save $1 million?” The answer will vary from person to person.

“One million dollars isn’t the magic number,” Scott said. “In most cases, it doesn’t even have to be close to that number.”

So, the first thing you need to do is calculate how much you need to have to retire and how much you should save each month to reach that goal. There are plenty of free online retirement calculators — such as ones at Fidelity, Schwab and Vanguard — that can help.

Once you know how much you need to set aside each month to reach your savings goal, you can create a plan to make it happen.

“Even if you don’t get to $1 million and you only get to $100,000, at least you’re not retiring on just Social Security,” Scott said.

Start Saving as Soon as Possible

The sooner you start saving, the less you’ll have to set aside each month to save $1 million for retirement — which is good news if your income is low.

“If you are age 30 today and invest $600 a month from now to age 65, if your investments earn an average return of 7 percent a year, by age 65 you’ll have $1 million,” said Dana Anspach, founder and CEO of financial planning firm Sensible Money. “If you’re starting at age 40, you’ll need to be able to put away about $1,300 a month to get to $1 million by age 65 — still assuming a 7 percent return.”

If you start saving at age 20, you could set aside less than $300 a month and have $1 million by age 65, assuming a 7 percent annual return. By starting at this younger age, you’d need to save half as much each month as you would have to if you waited until 30 and about one-fourth as much if you waited until 40 to start building a $1 million nest egg.

Find Room in Your Budget to Save

If you’re making less than $50,000 a year, you might be wondering how you can find room in your budget to save several hundred dollars a month.

“First, you have to want financial freedom just as much as you want other things in life,” Anspach said. Focusing on that goal helps you see the payoff from cutting costs from your budget, which can range from finding less-expensive housing to buying things used rather than new, she said.

“Even something as small as giving up soft drinks in favor of water can lead to big savings,” Anspach said. “Suppose you spend an average of $12 a week on soft drinks and tea. That’s $624 a year.”

Rosenblum said you can cut $250 out of your monthly budget easily to put into savings by opting for a lower-cost cable TV package, slashing your grocery bill by planning meals to eliminate food waste, and eating out or getting take-out less often. Resources such as 5 Dollar Dinners can help you make low-cost meals at home, she said.

Be Consistent

In reality, “becoming a millionaire is less about how much you make and more about consistency,” said Deacon Hayes, founder of WellKeptWallet.com and author of the forthcoming book, “You Can Retire Early!”

“One way to ensure that you actually invest consistently is by setting up an automatic transfer from your bank to your investing account," he said. "This way, you can stick to your investing strategy without much thought required each month.”

If your employer offers a workplace retirement plan such as a 401k, you can have contributions automatically deducted from your paycheck. If you were automatically enrolled in your employer’s plan, check your contribution amount to make sure you’re saving enough each month to reach your savings goal. “You need to be contributing a minimum of 10 percent of pay,” Scott said.

If you don’t have access to a workplace retirement plan, you can save for retirement on your own by setting up automatic transfers from your checking account to an individual retirement account, such as a Roth IRA or a solo 401k if you’re self-employed.

“Make [the] commitment to pay yourself first then work your lifestyle around what’s left,” Scott said.

Take Advantage of Matching Contributions From Your Employer

A great way to boost your retirement savings is to find out if your employer will match your contributions to your workplace retirement account. The most common match is a dollar-for-dollar match. But, typically, you have to save a certain percentage of your income to get the full match.

Twenty-five percent of employees miss out on this free money because they don’t contribute enough to their retirement plan to get their employer’s full matching contribution, according to Financial Engines, an independent investment adviser website.

“If you work for an employer that offers a retirement plan and a company match, be sure to contribute enough to receive the full employer match,” Anspach said. “Many employers match up to 3 percent of your pay. At $50,000 a year of income, that adds up to $1,500 a year of employer-provided funds.”

Save Your Tax Refund

If you get a big tax refund, you should put that money into retirement savings, Rosenblum said. The average refund for the 2017 filing season was $2,782, according to the IRS. If you earn $50,000 a year, stashing a refund of that size would be equivalent to saving about 6 percent of your income, she said.

Or, you could adjust your tax withholding by filling out a new Form W-4 to put more money back into your paycheck each month rather than get a big refund each spring. Then, use that extra money in your paycheck to boost your automatic contribution to your 401k or workplace retirement account.

Get a Side Gig to Boost Savings

Another way to come up with more cash to retire with $1 million is to get a side gig to boost your income. Both Scott and Rosenblum recommend finding a second job and stashing those earnings into a retirement or investment account.

You could open a Roth IRA and contribute up to $5,500 a year if you’re single and your modified adjusted gross income is less than $118,000 or married with a modified AGI of less than $186,000. The big benefit of this account is that you can withdraw money tax-free in retirement. Withdrawals in retirement from a 401k or traditional IRA are taxed as regular income.

Choose Investments That Offer Growth

To increase your chances of having $1 million in retirement, you need to invest your savings in assets that will grow.

“No one gets rich by saving in the bank,” said Byrke Sestok, a certified financial planner and president of Rightirement Wealth Partners in White Plains, N.Y. “If you have 30 years before retirement and 30 years during retirement, then you have the time to participate heavily or totally in the stock market, and ignore the big drops and focus on the fact that stocks have historically proved to be a better-performing asset class over bonds and cash.”

That doesn’t necessarily mean it’s up to you to pick the right stocks, though. See if your 401k or workplace retirement plan offers index funds, which track the performance of a broad stock market index such as the S&P 500. Or, Scott recommends target-date funds, which have managers who shift your portfolio allocation over time from stocks to more conservative investments as you near retirement age.

Opt for Alternative Investments

If you make less than $50,000 a year, there’s only so much you can afford to set aside in savings each month. So rather than save your way to $1 million, build your net worth through investing in real estate or starting a business, said Todd Tresidder, wealth coach at Financial Mentor.

“Think outside the traditional model — go to alternative assets,” he said.

Don’t assume your lower income limits your ability to pursue either of these alternative assets. You don’t necessarily have to have money to start a business, Tresidder said. You just need an idea, and you have to be willing to put in the hard work to make it happen.

If you want to invest in real estate, Tresidder said you can get a loan for a small, inexpensive property, fix it up on your own and flip it for a small profit. Then you can use that equity to buy your first rental property that will generate a stream of income.

Don’t Tap Retirement Savings Before You Retire

You can cash out a 401k when changing jobs, but that will seriously hurt your chances of saving $1 million for retirement.

“Don’t ever do that,” Scott said. “That is very destructive to your retirement security.”

Not only will you have to pay state and federal income taxes, but also you will have to pay a 10 percent early withdrawal penalty on the money you withdraw. Plus, most people don’t go back and replace what is withdrawn, Scott said. So, they miss out on investment earnings.

To avoid having to tap retirement savings — whether it’s to get you through a period of unemployment or to pay for emergencies — Scott recommends that you build an emergency fund. Set aside cash in a savings account each month so you can access if you’re hit with an unexpected expense.

“You don’t want to be in a situation where you’re in an emergency and raid your retirement account,” she said. “That’s counterproductive.”

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Clearly, there are unforeseen circumstances in which using your retirement savings might be necessary. Medical and financial emergencies frequently come without warning, and if you have significant debts with high interest rates, dipping into your IRA or 401k could be an attractive option for some.

However, it’s still important to remember that two of the best ways to deal with debt are to spend and budget wisely or consolidate your higher-interest debt with a personal loan.

Save Money by Opting for a Personal Loan

In every case, turning to retirement savings is a costly consequence of failing to plan and prepare adequately — and there are usually better options available.

When you consider the heavy tax penalties that come with pulling your money out of a 401k prematurely — as well as the opportunity cost of not letting that money collect investment returns — a personal loan could be a lower-cost solution in the long run. You can pay the money back with fixed monthly payments and a set interest rate determined when the loan is originated. This simple option avoids those tax penalties and leaves your retirement savings where it should be: earning even more money in your retirement account. Additionally, many personal lenders, like Discover Personal Loans, let you choose your loan amount and term. Discover also offers another important feature that not every lender does — zero origination fees.

In a Discover Personal Loans survey, 22 percent of respondents cited the biggest benefit of a personal loan is lower interest rates as compared to other borrowing options and 21 percent cited it as a quick way to get money. Meanwhile, 68 percent of those who took out a personal loan said it allowed them to accomplish their financial goals.

“Our 2017 survey showed that more than half the people surveyed have less than $5,000 in savings to cover unexpected or emergency expenses,” said Matysik. “In those situations, a personal loan could offer quick access to funds to manage those bigger expenses in a pinch, with repayment plans that fit your budget.”

Additionally, some of the more common uses of personal loans were the same circumstances that led people in the GOBankingRates survey to tap their retirement savings early: over one in four people used a personal loan to cover a medical expense, and over one in five used it for debt consolidation.

Personal loans can be a simple alternative to accessing retirement accounts early when paying down debt as it consolidates all of your higher-interest debt bills into one fixed monthly payment, ideally at a lower interest rate than your other debts. Personal loans can also offer you funds fairly quickly with fixed-interest rates and a set repayment period. Personal loans are not taxed, and some lenders, like Discover, can pay your creditors directly, taking the financial burden off you to pay all bills.

All-in-all, an IRA or 401k is an excellent tool for building your net worth in preparation for when you retire, but it’s not an efficient way to cover emergency expenses or pay down debt. Consider tapping a retirement account as a tool of last resort.

Keep reading to learn more about retirement accounts.

Methodology: This survey was conducted via Survata and collected responses from 1,972 people. The survey posed a screener question, “Have you tapped into your retirement savings early?” Those who responded “yes” were then asked, “What’s the main reason you tapped into your retirement savings early?” and could choose from the following answer choices: 1) to pay for a financial emergency (i.e. job loss); 2) to pay for higher education; 3) to pay for medical expenses/healthcare; 4) to pay off debt and/or bills; and 5) to purchase a home. The findings are representative of the U.S. online population with a margin of error of 4.50 percent. This survey ran and collected responses from Feb. 24, 2018, to March 1, 2018.

This article originally appeared on GOBankingRates.com: Here’s Why 44% of Americans Tap Their Retirement Savings Early

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