Emergency withdrawals from retirement account can hurt now and later

The more financial emergencies people have, the more likely they are to make withdraw money from a retirement account early, a study shows, which may leave people short of retirement funds.
The more financial emergencies people have, the more likely they are to make withdraw money from a retirement account early, a study shows, which may leave people short of retirement funds. TNS

It’s a financial shock when the car quits working or the furnace gives out and there are no savings to pay for repairs or replacements.

Last year about 13 percent of people with retirement accounts said they drew on those accounts at the same time they had a financial shock, according to a report by The Pew Charitable Trust. Only 2 percent with a retirement account made a withdrawal but reported no financial shock.

For those saving for retirement or close to retirement, that can trigger tax and early withdrawal penalties if under age 59. It also can be so hard to catch up, it will lower their retirement payments permanently, said Alison Shelton, senior officer for The Pew Charitable Trusts’ retirement savings project.

When times are tough due to unemployment, a pay cut, a divorce or death of a spouse is when people are most likely to have withdrawn from their retirement accounts, the survey showed.

“In some cases it may make sense,” Shelton said. Early withdraws may prevent further economic issues such as fixing a roof to protect an investment in a house or repairing a car to keep a job, she said. It also may be an option for those families who are very constrained in access to credit, she said.

The survey covered the 15 percent who took loans or distributions for one year, Shelton said. Over the course of many years, she said, many families may experience a major shock and tap into their retirement.

The survey focused on respondents age 20 to 58 who were not retired and did not have a retired spouse. It showed:

▪  As the number of financial shocks experienced increased, so did the likelihood that a household had drawn on its retirement account.

▪  41 percent of households did not have enough liquid savings to cover the $2,000 cost of the median “most expensive financial shock.”

▪  31 percent said the most expensive financial shocks were car repairs and 30 percent said it was a pay cut or unemployment

▪  People with lower incomes were more likely to withdraw money from retirement account.

▪  Those with more education were less likely to tap into their retirement account that those with a high school diploma or some college

▪  27 percent of African-Americans and 14 percent of Hispanics drew on their accounts during a financial shock compared to 12 percent of whites and 10 percent of Asian-Americans and Pacific Islanders

“This research underscores earlier Pew studies that found that many American families are under financial stress, experiencing medical, employment or other shocks, and having insufficient liquid resources to deal with them,” Shelton said.

Stopping early withdrawal isn’t the answer, she said, because many employees may not contribute at all if they can’t access their money. Instead some employers are beginning to think about offering “sidecar” savings accounts, she said, to help families save for rainy days in addition to retirement accounts.

Tips to help prepare for unexpected expenses

Ben Schrock, an investment adviser representative and president of B.A. Schrock Financial Group, gives this advice for saving for the unexpected:

• Create a budget and don’t deviate. “The more you stick to the budget and put some aside for those rainy days, the better off you’ll be when it pours,” he said.

• Make savings the emergency fund. You want to steadily build it so you don’t tap into your retirement funds – and pay a penalty on top.

• Setting up different savings accounts for certain types of expenses is a good idea, rather than raiding one general savings account for all expenses.

• Make it automatic. Earmark a certain amount in your paycheck to be set aside, similar to a 401(k).