With easy, large home equity loans no longer an option for many homeowners, tapping into 401Ks and other retirement funds has become the way to finance large purchases or bills, including college tuition, medical payments, or even vacations. Many buyers also tap into retirement savings to increase down payments on homes, making it more possible to finance bigger mortgages during times that are less favorable for lending. According to CNBC, the IRS collected around $5.7 billion in early withdrawal penalties in 2011 alone, which means individuals withdrew a total of $57 billion from retirement funds in a single year. Financial experts are beginning to warn against using this tactic to fund home and other large purchases.
Tapping into Funds Decreases Value
The penalty for withdrawing from retirement funds before reaching the age of retirement is 10 percent. If you withdraw $20,000 for a down payment on a home, you’ll pay the IRS $2,000 in penalties for the year. That’s $2,000 lost from the value of your fund without any real return.
You can borrow from some retirement accounts without paying the 10 percent penalty, but that means borrowed funds are no longer invested in money-bearing accounts. In most cases, it takes years to repay large loans to your account. According to a study from TIAA-CREF, over half of individuals who borrow from retirement funds also reduce contributions to the fund while paying back the loan. Reasons for this include financial strains that caused the need for the loan in the first place or the fact that individuals reduce contributions because they are also making the loan payment. The overall impact to final retirement numbers can be thousands of dollars or more in lost interest.
Immediate Gratification Can Damage Future Financial Viability
Covering today’s needs with tomorrow’s money can damage future financial stability, especially for individuals who borrow from retirement funds later in life. Borrowing a substantial amount ten or fifteen years prior to retirement to fund a home purchase could put you in a situation where retirement payouts are not enough to cover mortgage payments, for example.
Is it Ever Okay to Tap into Retirement?
Some situations may be favorable for tapping into retirement, especially if you can borrow from your fund without incurring the 10 percent tax penalty. Using retirement to cover schooling that could substantially increase income potential might lead to a situation where you can increase your retirement fund quickly in the future. Younger individuals funding a home purchase with the help of retirement funds often have plenty of time to pay back the loan so there isn’t as large a final impact to retirement numbers.
It might also be a good idea to tap retirement funds in emergency situations where the alternative is bankruptcy, serious debt, or failure to take advantage of something like necessary medical treatments.
Planning Is Essential
Whether you’re leaving your retirement funds alone or thinking about tapping into them for today’s needs, planning is essential for success now and in the future. Find out more about investing for retirement to grow your funds for future stability or to make up for today’s spending.