If you want to safeguard your retirement, one of the most important things you can do is to avoid withdrawing money from 401k accounts. That’s the case even if you can take money out without a penalty. Here’s why.
Let’s say you are 35 years old with a $100,000 in your 401k. You earn $65,000 a year and get 1% raises each year. In addition, you contribute 6% to your 401k each year and the account grows by 7% on average each year.
To illustrate the real cost of withdrawing money from your 401k, let’s compare what happens to the account under two different scenarios. Option one is where you don’t withdraw any money from the account. Option two illustrates what happens to the account if you withdraw $60,000 5 years down the road at age 40.
Under situation #1, your account grows to more than $1.2 million by the time you reach age 68. Under situation #2, the account grows to a bit over $900k – a $300,000 shortfall. And the consequences don’t stop there.
Assume that once you retire you withdraw 4% of your account each year to supplement your income. Because your account is $300,000 lighter, your income will be $12,000 a year lower – for life. That’s expensive.
How You Can Avoid This Problem
1. First and foremost, don’t spend money you don’t have. Lots of people have “wants” they believe are “needs”. Unless you are talking about a medical emergency or long stint of unemployment that is unavoidable, you shouldn’t even consider slicing into your retirement money.
2. Your next step is to have an adequate emergency fund. Of course there is no “one size fits all” when it comes to your emergency savings. You have to determine the correct amount for your unique situation. But after having enough life insurance, this is the most important building block of your financial plan. You don’t want to get caught a day late and a dollar short my friend.
3. Next, track your spending. This isn’t necessarily meant to curtail what goes out each month. You track your spending in order to make sure you have enough money for events in your life as they unfold. By tracking your spending month in and month out, you’ll know what it costs you to live rather than have to guess. Lots of people are aware of their “normal” monthly costs like rent and groceries. But they forget about the unexpected items that are actually very predictable. I’m talking about expenses like insurance, repairs, auto replacement etc. These aren’t monthly costs so they are easily forgotten. And because people fail to plan for these kinds of expenses, they often get taken unawares. Ouchie.
Track your monthly outflow and this won’t happen to you. And this way you won’t be taken by surprise. Because you’ll be prepared, the odds are you won’t have to tap into that 401k cookie jar when times get rough.
4. Your next step is to set up a home equity line of credit if you own property. This can act as an emergency source of cash in sticky situations.
This all sounds good I know, but if you are between a rock and a hard place right now, you may not have the time to get all this in motion.
5. If that describes you, contact friends and family or consider peer to peer lending to tide you over until you land on your feet.
Whatever it takes, avoid raiding your 401k or other retirement accounts if at all possible. My experience tells me that once people open that Pandora’s Box they rarely shut the lid until they exhaust the funds.
What’s been your experience? Have you ever borrowed from your 401k? Did you repay it?