Breaking the sacred nest egg

Advisers must take every opportunity to explain the foolhardiness of dipping into retirement savings early — especially when there is a penalty attached

May 18, 2014 @ 12:01 am

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(Roger Schillerstrom)

For many Americans saving for retirement, their company's 401(k) plan represents the lion's share of their nest egg. Most workers can no longer look forward to a pension, so the money in their 401(k), along with Social Security and any other money they've managed to salt away, is going to have to see them through their golden years.

But now we hear that these 401(k) plans are at risk. Who's to blame? This time, it's not mutual fund companies or record keepers charging exorbitant fees ripping off workers.

No, it's the workers themselves.

It seems that an increasing number of employees are raiding their own 401(k) plans early, taking the money out years before their retirement. And neither the diminished size of their nest egg nor the 10% penalty that these workers have to pay on the amount of the early withdrawal is proving to be enough of a deterrent to dissuade them.


Bloomberg News reported last week that the Internal Revenue Service in 2011 collected $5.7 billion in 401(k) penalties on the $57 billion taken out of 401(k) plans early. Adjusted for inflation, the IRS collects 37% more money from early withdrawal penalties than in did in 2003.

It's bad enough that employees don't save anywhere near the amount needed to fund a successful retirement in the first place, and these early withdrawals promise to make the brewing retirement crisis even worse.


No one knows for sure what this money is being used for, but anecdotal evidence suggests that for many Americans, the 401(k) plan has become a de facto emergency fund.

Up until the collapse in home values during the Great Recession, people's houses served as their piggy banks. Thanks to ever- increasing valuations, homeowners could tap the equity in their home whenever they were facing lean times, be it for a leaky roof that needed to be replaced or to tide them over after a layoff.

That pretty much came to an end after housing values plummeted, wiping out trillions in home equity. By 2013, the amount of home equity loans outstanding was $704 billion, down 38% from 2007.

No longer able to pull money out of their homes, workers set their sights on their 401(k) plans. By 2010, a record number of Americans had made early withdrawals, according to Bloomberg.


The danger of this practice should be apparent to anyone trying to save for retirement. Research shows that young workers 20 to 39 are among the top offenders, with many of them withdrawing money from their 401(k) plans when they switch jobs. If they have saved only a few thousand dollars at that point, they don't see the value in rolling it over and are willing to pay the penalties.

But workers, no matter what age, have to start saving sometime. Studies show the earlier the better. Contributing to a 401(k) plan, only to withdraw the money a few years later — well before retirement starts — is the equivalent of taking two steps forward and one step back.

As financial professionals, advisers must take every opportunity to explain the foolhardiness of dipping into retirement savings early — especially when there is a penalty attached — no matter how good the cause seems to be at the time.

The government, in its financial literacy programs, should also emphasize that 401(k) plan money should be sacred. After all, Americans' retirement is at stake.


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