Americans aren’t just bad at saving for retirement. They’re also pretty terrible at keeping the money they do save safe for the future. Close to a third of people have made withdrawals from their 401(k) to pay for non-retirement expenses. And 44% of people say they expect to do so in the future, PricewaterhouseCooper’s 2017 Employee Financial Wellness survey found.
For many, those early withdrawals are a huge financial mistake. For one, there are taxes and penalties you’ll usually pay when you tap your savings before your retire. Worse, siphoning off funds from your 401(k) now means thousands of dollars lost in potential earnings.
What kind of numbers are we talking about? A 30-year-old who takes $16,000 from his 401(k) would lose nearly $4,000 to taxes and penalties and have $471 less in retirement income every month, assuming he retires at 67 and lives for another 26 years, according to Fidelity.
Still, retirement is far away. And today’s financial needs are pressing, which can make it hard to resist the temptation to borrow a bit from your savings. Fortunately, there’s often a better solution to your financial woes than draining your 401(k). Here are the five most common reasons people gave for raiding their retirement savings — and what you can do instead.
1. To buy a home
Seven percent of millennials, 3% of Gen Xers, and 2% of baby boomers said they expected to take money from their retirement account to buy a home. More lenient IRS rules on retirement account withdrawals for first-time homebuyers could be tempting some people to tap those funds, taking advantage of what’s known as a “hardship withdrawal.”
Not only can you take as much as $10,000 from your 401(k) or IRA to buy a house, but if the money comes from your IRA, there’s no 10% penalty on the withdrawal. (You can also withdraw contributions to your Roth IRA at any time without a penalty or tax.) But just because the IRS says you can use your retirement nest egg to purchase real estate doesn’t necessarily mean you should.
Next: How to buy a house and protect your retirement savings at the same time.
Buy a house without tapping your retirement funds
Before raiding your retirement account to cover a down payment, make sure you’ve considered all your options. Consider cutting back in other areas to build up your down payment fund. Or look for ways to boost your income. Some people even temporarily dial back retirement contributions as they save for their first place. (If you do this, you should still save enough, so you get your company match.) You can also look to down payment assistance programs and low-money-down loans if money is tight.
Furthermore, you can borrow money from your 401(k) rather than making a hardship withdrawal. You’ll avoid paying taxes and a penalty with this move. But it has downsides. You might not be able to save as much for retirement as you pay back the loan, for one. Plus, the entire loan balance will likely be due immediately if you lose your job.
2. To pay for education expenses
Five percent of millennials and Gen Xers and 1% of baby boomers say they expect to borrow money from their retirement accounts to pay for educational expenses. As with first-time home purchases, the IRS also allows hardship withdrawals from retirement accounts to pay college costs for yourself, your spouse, or your kids. But they come with a 10% penalty, plus taxes.
Next: 5% of American families yanked an average of $4,814 out of their 401(k) or IRA to cover educational expenses in 2016, according to data from Sallie Mae. There are better ways to pay the tuition bill.
Pay for college without tapping your retirement funds
If you hope to help your children pay for college, the key is to start planning when they’re relatively young. Many parents stash money in a 529 or Coverdell Education Savings Account, both of which offer tax advantages. Others save in a general investment or savings account or participate in pre-paid tuition plans. If you begin saving early, you might be able to accumulate enough to cover all or most of your child’s college costs.
What if your child’s already out touring campuses, and you haven’t managed to start saving? Don’t smash your retirement piggy bank in a panic. Your retirement savings should take priority over paying for your kid’s college education, according to financial experts.
Your child can borrow money to pay for college, but you have to pay for retirement yourself. Adjusting spending in other areas and steering your kid toward cheaper colleges can also help make the cost of your son or daughter’s degree more manageable without jeopardizing your financial future.
3. To pay off a credit card
Needing to pay off a credit card was the third-most common reason people anticipated taking money from their retirement account. Twelve percent of millennials, 11% of Gen Xers, and 9% of baby boomers said they thought they’d eventually have to tap their 401(k) to get out from under their debt. Except in rare instances, you should avoid using your retirement funds to pay off your consumer debt.
Next: Alternative strategies for paying off credit card debt
Pay credit card debt without tapping your retirement funds
Unless your financial circumstances are truly dire, turning to your IRA to pay off credit card debt is usually a bad move. Penalties and taxes make this a high-cost way to pay your bills, unless you’re paying very high interest on your credit card debt, according to Investopedia.
Even then, there are likely better alternatives than stealing from your IRA. (Unless you’re changing jobs, you won’t be able to get money to pay your credit card bills from your 401(k) because it doesn’t count as a hardship withdrawal.)
If paying your credit card bills is a struggle, you might be able to negotiate a lower rate with your lender, transfer the balance to a low-rate card, consolidate your debt, or take out a personal loan or 401(k) loan to pay down the balance. You might even consider diverting some of your retirement savings to your credit card payments, especially if the interest rate on your debt is higher than what you’d earn in your investments (hint: it probably is).
One more thing to remember: Your 401(k) is protected during a bankruptcy proceeding, so it might not be worth it to cash out your retirement to pay your creditors if you suspect a bankruptcy is in your future.
4. To pay medical bills
Roughly a quarter of Americans say they or someone they live with has had trouble paying their medical bills in the past year, a Kaiser Family Foundation/New York Times survey found. So it’s not totally surprising that close to 25% of boomers, 18% of Gen Xers, and 22% of millennials say they think they’ll have to use retirement money to cover the cost of doctor bills and medical treatments.
The IRS does allow 401(k) withdrawals to cover medical bills, and you might be able to avoid the 10% penalty if the bills are significant.
Next: Sky-high medical bills are a big problem for many people, but there might be a better way to deal with them than liquidating your 401(k).
Pay medical bills without tapping your retirement funds
Uninsured people were far more likely than those with insurance to have trouble paying medical bills, the Kaiser survey found. Those with high-deductible insurance coverage also struggled more to pay for health care. If you don’t have insurance, getting coverage now can help prevent a medical emergency from upending your financial life.
If you have a high-deductible plan, contribute to a health savings account, so you’ll have money to pay for co-pays, deductibles, and other medical costs. Doing this can even increase your retirement security because you can also use that money to pay for medical care in retirement.
Before you turn to your 401(k) to cover your bills, try negotiating with the hospital to lower your payments, ask your provider about a payment plan, or look into assistance programs, suggested Patti Lamberti of Money Under 30. Lamberti was hit with $6,000 in copays after she gave birth to her daughter. Many hospitals have fee-reduction programs, according to the Kaiser survey. And nonprofit hospitals are required to have them.
5. To deal with an unexpected expense
Over half of survey respondents in all age groups said they’d probably have to withdraw money from their 401(k) before retirement to cover out-of-the-blue expenses. Given that Americans are woefully unprepared for financial emergencies — most have less than $1,000 in savings — it’s hardly a shock that many see their retirement nest egg as a buffer against financial disaster.
Next: How to handle a financial emergency without raiding your 401(k)
Pay unexpected expenses without tapping your retirement funds
Treating your 401(k) as a piggy bank for life’s little emergencies is a bad idea. The costs of withdrawals and the lost potential for growth usually mean you’re hurting yourself more than helping when you use your retirement funds to pay for today’s expenses.
Plus, you might not even be able to get at the money. Early withdrawals from a 401(k) are only allowed in the case of hardship, and “the water heater broke” doesn’t count. You can borrow from your 401(k) or withdraw funds from your IRA, though that doesn’t mean you should.
Instead of treating your retirement savings as an emergency fund, create a dedicated savings account to cover unexpected expenses. It’s OK to start small. Saving just a few dollars a week adds up over time. Soon you’ll have enough to cover minor financial surprises. Cutting back on extras, selling stuff you no longer use, or getting a temporary part-time job can make your savings grow even faster.