16% of Savers Are Dipping Into Their 401(k)s. Here's Why That's a Huge Problem

We're grappling with tricky economic times these days. Inflation is still surging, recession fears are looming, and many people are worried about their jobs ending up on the chopping block. Throw in the fact that a lot of people already have debt and raided their savings accounts, and it's not surprising to learn that 53% of Americans say their personal financial situation has deteriorated, according to a recent Quicken survey.

That same survey, however, also reveals that 16% of people are dipping into their 401(k) plans due to their financial challenges. And that's a problem on multiple fronts. 

The issue with raiding a 401(k)

The problem with tapping a 401(k) plan is twofold. First, if you're not yet 59 1/2 years old, taking a 401(k) plan withdrawal means facing a 10% penalty on the sum you remove. Incidentally, the same rules apply for IRAs.

So, let's say you take $5,000 out of your 401(k) plan to deal with bills your regular paycheck can't cover. In doing so, you're looking at losing $500 to a penalty off the bat.

Plus, if you have your money in a traditional 401(k) plan, not a Roth, your withdrawal will also be subject to taxes. Now to be fair, the same would hold true for a 401(k) withdrawal taken during retirement. But all told, there are some immediate costs you might incur if you take money out of your 401(k) plan. 

Another issue with raiding your 401(k)? The more money you remove now, ahead of retirement, the less money you'll have during retirement, when you're apt to need cash reserves to cover your living costs. 

Also remember that 401(k) plans get invested. So let's say your 401(k) only generates an average yearly 6% return. That's actually a fairly conservative return, because the stock market's average over the past 50 years, as measured by the S&P 500 index, is 10% before inflation. If you take a $5,000 withdrawal now at, say, age 40, but you're not retiring for another 25 years, that withdrawal will actually end up costing you about $21,500 when you factor in lost gains.

A better way to access money

If you're thinking of taking a withdrawal from your 401(k) plan to cope with higher expenses or to address another need, you may be in a pretty desperate spot. But before you raid your 401(k), think about the other options that may be available to you.

If your credit is in good shape (meaning, you have a score in the 700s or higher), you might qualify for a decent interest rate on a personal loan, which could be a relatively affordable way to borrow. Granted, borrowing rates are up right now. So even with good credit, you may be looking at a higher interest rate on a personal loan than usual. But it's an option worth considering so you can leave your 401(k) plan alone.

Similarly, if you own a home you have equity in, borrowing against it may be doable. Your choices there include a home equity loan and home equity line of credit, or HELOC.

All told, it pays to explore different options before removing a chunk of money from your 401(k) plan. Avoiding that route could mean steering clear of costly penalties and giving your money the opportunity to keep growing the way you want it to.