Americans are saving more for retirement, but a new report from the American Investment Institute shows too many are tapping those funds prematurely, costing them billions of dollars.
Retirement account rules assess steep penalties if you withdraw money before age 59 ½. But many people often find they need cash before then, and the bulk or their savings are in retirement accounts.
If you withdraw money from a tax-deferred retirement account before you are eligible, you not only have to pay tax on the withdrawal but are assessed an additional 10 percent penalty. A lot of savers, it appears, are paying that penalty.
The American Investment Institute study shows the Internal Revenue Service (IRS) collected around $5.7 billion dollars in penalties from retirement plans in 2017, which is the latest year for which data is available. Using simple math, those numbers reveal that Americans took about $57 billion in premature retirement account distributions.
That’s troubling for two reasons. Not only are savers losing money to penalties, but they’re also reducing the amount of their retirement savings.
$11,000 average withdrawal
By using simple math again, the study’s authors conclude that the average amount taken in an early, non-exempt withdrawal was roughly $11,100 per tax return. That might explain why people had to turn to their retirement accounts as a last resort -- not that many people have $11,000 sitting in a savings account.
While saving for retirement is something to be encouraged, consumers should be mindful of other financial needs they may face. If all of their money is tied up in retirement accounts that can’t be accessed without a penalty until years in the future, they could face unnecessary expenses.
Other sources of emergency cash could include an emergency savings account or a loan. If you have a 401(k) account, you may be eligible to take a 401(k) loan. You can “borrow” up to half of the money in your account -- up to $50,000 -- if you pay it back within five years. Paying interest on a loan will likely be less costly than paying a 10 percent penalty.
If you’re a homeowner with equity in your property, you may qualify for a home equity line of credit (HELOC) at a fairly low interest rate. That may also be a less costly option when you need emergency cash.