Some people without cash reserves end up drawing on their retirement accounts, putting them at risk of shortfalls later in life, according to an analysis published Wednesday by the Pew Charitable Trusts.
About 13 per cent of working-age people with retirement accounts said they had drawn on their nest egg in the previous year and had suffered a financial setback, such as a major car repair or job loss, in the same period, Pew found. (Just 2 per cent said they had made a withdrawal but hadn’t had a financial shock.)
The typical amount of the most expensive financial shock reported was $2,000 (Dh7,340).
The findings highlight the need for new ways to encourage people to save for unplanned financial jolts, said Alison Shelton, a senior research officer with Pew’s retirement savings project, who discussed the report in a call with journalists.
“There’s a need to help people save for the short term,” she said.
The report is based on a new analysis of data from Pew’s Survey of American Family Finances, focusing on Americans ages 20 to 58 who were not retired and did not have a retired spouse. (The survey, a representative sample of more than 5,600 households, was conducted in two waves, in 2014 and 2015.)
The ability to use retirement funds prematurely can help people weather cash shortfalls and perhaps avoid cascading financial problems. But, Shelton said, it can also permanently lower retirement savings, because it’s hard to catch back up.
People who withdraw money from certain retirement accounts like 401(k)s or individual retirement accounts before age 59 1/2, the report noted, typically have to pay income taxes on the money as well as a 10 per cent tax penalty.
Borrowing money from a 401(k), as some employers allow, can also dent the accumulation of retirement funds, because the worker loses any investment gains on the money that was borrowed.
As might be expected, people with lower incomes were more likely to draw on their retirement accounts. And the likelihood that workers would draw on their retirement funds increased as the size of the financial shock rose, relative to their monthly income.
Here are some questions and answers about emergency funds and retirement savings:
Is it always a bad idea to borrow from my retirement account?
If doing so allows people to avoid a more dire financial hit, such as losing a home or a car needed for work, it may make sense, Shelton said. Borrowing from retirement funds also could mean people avoid higher-cost alternatives, such as a car title loan. Some people might choose not to participate in retirement plans at all, Shelton said, if they didn’t have the option to use the money when they need it.
How can I build emergency savings?
Michael Kalscheur, a senior financial consultant with Castle Wealth Advisors in Indianapolis, suggests working initially toward a goal that seems attainable — say, saving the equivalent of one pay cheque.
While saving for retirement is important, consumers who lack liquid savings should consider whether they may be putting more into a retirement account than they can truly afford, Kalscheur said. One approach might be to put enough into your 401(k) to get your employer’s matching contribution, he said, and then contribute cash to your emergency fund. Once that reserve is built up, you can increase contributions to retirement savings.
Are any employers offering their workers help with short-term savings?
New tools are emerging to address the need for emergency savings. The start-up DoubleNet Pay in Atlanta, for instance, works with employers and payroll providers to automate emergency savings. Employees can have money deducted from their paychecks and transferred directly to a savings account at the same time they are having money deducted for health insurance premiums and retirement savings.
“The idea is to get those contributions out of the way on payday,” said Brian Cosgray, the company’s founder and chief executive.
Another option gaining attention would give workers the option of contributing automatically to “sidecar” savings accounts, maintained within their traditional retirement plans.
David Mitchell, senior program manager at the Aspen Institute’s financial security program, said that while it took a bit of effort, workers could set up their own automatic savings plans. If you have direct deposit for your paycheck, you can arrange to have it split between your checking account and a savings account.
