In his blog post “More Than 25 Percent of Americans Are Making a Huge Financial Mistake“, Trent Hamm of The Simple Dollar reports that this year a quarter of Americans are withdrawing money early from their 401(k)s. He explains:
The only way this even looks like a good idea at all is if you’re looking only at the very, very short term. If you look beyond that, making this move is pretty clearly worse than using a high-interest credit card to pay your bills. In fact, if we’re comparing disastrously bad financial moves, I’d actually prefer to use a credit card cash advance to pay a bill than pull money out of my 401(k) early.
He points out Wells Fargo’s “401(k) Early Withdrawal Costs Calculator” and runs the numbers to prove his point. If you were trying to take $20,000 out of a Pre-Tax 401(k) under 33% federal income tax and 5% state income tax, between taxes and the early withdrawal penalty, you would lose half of the money you were trying to take out instantly.
Furthermore, if you had left the money, you would have gotten a 7% annual return for the next several years and would have had more to supplement your retired lifestyle for years and years in retirement. If you’d been taking out $20,000, you’ll only receive $10,400 of it now at the sacrifice of an extra $3,000 per year for your entire retired life. Clearly a bad move.
For those of you who don’t yet find themselves in a pinch, you should live within your means and squirrel away money while you can. Don’t let your paycheck go to waste. Keep your credit card balance low. Save money where possible, like brown bagging your lunch. And always get your employer 401(k) match.
Avoid finding yourself in a pinch by budgeting. Practice thrift. Avoid impulsive shopping and set limits for yourself. Practice waiting a week on impulsive desires as well as delay major purchases. Budget for surprises and budget busters.
Lastly, try to avoid the 6 Budgeting Pitfalls.
If you are in a pinch, don’t be afraid to ask for help. Call a financial advisor and find out what the best options are for you. If debt is your problem, figure out which debts you should pay off first. If you need cash, look at your possessions, monthly fees, and habits. You can cancel subscriptions, sell old books, clean out your closet, and turn your lights off.
Look critically at your life and chances are you’ll find the cash you need without making such a horrible move as pulling money from your retirement.
Photo used here under Flickr Creative Commons.