Caught between a rock and a hard place. Desperate to make a choice or face the consequences. An interest rate that's almost half of the total loan.
Sounds like the situation faced by the latest victim on an episode of The Sopranos, right?
Sadly, it's not. This is what's happening in the United States today. According to the financial advisory firm HelloWallet, more than one in four American workers with 401(k) plans and other retirement savings accounts use them to pay current expenses–stuff like mortgage payments, credit card debt or other bills. To do this, they're taking a hit to the tune of a 10% early withdrawal penalty–plus their tax rate. Sounds about as fun as ... well, doing business with the Sopranos.
The consequences of a 401(k) raid are not always immediately visible. But once they become apparent, it's a hard hit. Very hard. Employees and their bosses put $293 billion a year into their accounts, and early withdrawals, cash-outs and loans against those savings take nearly a quarter of that amount.
Between the 10% penalty and at an average tax rate of around 25% or 28%, that means a person who borrows from their retirement plan before they are of age loses almost 40% of the money before they even get it home! And chances are they aren't the best money-managers, so they may have to do it again.
On top of that, when you cut into your long-term savings, it severely hampers what compound interest can do for you. Let's say you have $80,000 saved at age 35. If you leave it alone and don't add any money, it will become about $1.58 million when you hit age 60 (with 12% growth). But if you take out $20,000 to get yourself out of debt, the remaining $60,000 will only reach $1.18 million.
One withdrawal results in a $400,000 loss. Jaw-dropping.
Simply making a budget and sticking to it would take care of 90% of the reasons people withdrawal from their retirement. When you make a spending plan, you don't buy what you can't afford. You don't get desperate because your purchases back you into a corner. By not using credit cards, you don't cut into an investment growing at 12% so you can pay for a purchase at 24%.
Stay away from debt and make a budget. That's a much better choice than digging into your nest egg before it's time.
Source: The Washington Post