Cross Posted: Workplace Prof Blog
A follow-up to yesterday’s post discussing stagnating wages and later retirement ages (this one from the Washington Post):
Six months ago, Ivan Sanchez was optimistic about his future. He had recently earned a bachelor’s degree in business management and was writing a book about growing up among gangs and guns in the Bronx.
Then he was threatened by something else: a credit card bill, student and car loan debt, higher gas bills and rising rent. With two high school age children in need of clothing and school supplies and a toddler in need of much more, it didn’t take very long for Sanchez’s optimism to fade. That’s when he decided to do what any financial planner would advise against: He dipped into his 401(k) retirement plan.
“There’s no other way I could do it,” said Sanchez, a 35-year-old Virginia Beach resident.
Hard economic times are driving some people to take actions that could jeopardize their futures. With home equity lines of credit and other types of loans harder to get, employees are increasingly raiding their retirement plans to take care of immediate needs such as paying down debt and medical bills, staving off foreclosure, or simply covering higher food and fuel prices.
It sounds like a necessity in this case and other cases where financial need overwhelms other considerations. But consider this chart I posted a while ago about the impact of higher mutual fund fees. The same impact is felt when 401(k) assets are withdrawn before maturity. Moreover, participants must pay a 10% excise tax, in addition to paying income tax on the distribution if before age 59.5.
This is expensive money! A person is probably better off taking a loan from the bank at a lower interest rate if possible.
Hat Tip: Dennis Walsh
PS
This guy is not very savvy for having a business degree. As far as I know, not only will you pay the 10% penalty for taking the money out, the money will then also be taxed at ordinary income rates. In other words, about 1/2 that money will be gone (of course, he will get taxed later when he takes it out for retirement, but by then people are usually taking out less than what they made when they were younger, and thus have a lower tax rate). Additionally, many companies with whom you have the 401k will let you borrow against it; if not, I imagine a bank will.
I also question the article saying rising rent; in today’s market rent will likely rise a little, but even then it is often just enough to keep up with inflation which isn’t too high right now. Also, the low interest rates of recent years led to massive oversupply in housing, which should mean a decrease or at least reasonable rental prices. Of course, the New York area may be a whole different world.