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The worst way to cover holiday costs

Saving for retirement is never easy, especially when you have competing demands on your money. When those demands come from your children, it's even harder.

Small wonder, then, that 49 percent of Americans in a recent poll commissioned by RBC Wealth Management said they put more emphasis on saving for their children's education than on building up a nest egg for their own future.

"Everybody kind of defaults to the most immediate need, but you have to plan your way through that these days," said John Taft, CEO of RBC Wealth Management in the U.S. "You can't just roll into retirement — you'll never get there."

But funding kids' education is far from the worst thing people do instead of saving for retirement. A November study by T. Rowe Price found that 62 percent of parents say they spent more for their kids than they should have over the holidays, and 7 percent, including those who say they have not overspent, have tapped retirement savings to cover holiday costs.

Within those tapping retirement savings, 6 percent self identified as savers, said Stuart Ritter, senior financial planner and vice president at T. Rowe Price.

"I was really surprised," he said. "People should be thinking more broadly than just the holiday season."

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Holiday spending is an annual ritual, of course, and in 2014, American consumers spent an average of $802 on holiday gifts, decor and the like, according to the National Retail Federation.

With median family income at $65,910 in the most recent census data, that kind of spending money can be tough to come up with. Sure enough, roughly 1 in 5 employees with access to 401(k) plans allowing loans had one outstanding in 2013, according to the Employee Benefit Research Institute, a figure that has been unchanged for several years. The average balance that year was $7,421, up from $7,153 in 2012.

Christmas gifts
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That may not seem like much of a loan, but tapping a retirement account early entails costs far out of proportion to any immediate gain, according to Ric Edelman, chairman and CEO of Edelman Financial Services. For one thing, he said, the younger you are when you do it, the more you stand to lose out on the potential tax deferred growth of that investment.

Some studies have found that every $10,000 you take out of a 401(k) can reduce your future retirement balance by $100,000, he said.

"The worst part" of taking money out of retirement savings "is the much larger spending in the future you are giving up in return for the money you take out," said Ritter.

In addition, early withdrawals from a 401(k) account come with built-in costs: if you leave or lose your job before paying the money back, you may owe ordinary income taxes on what you take out. And even if you stay with your current employer, if you fail to pay back the money by the deadline, you will almost certainly incur a 10 percent federal tax penalty.

There are other downsides as well. You will have to pay interest on your 401(k) loan, and some plans do not allow you to contribute while you have a loan outstanding.

Edelman pointed out that while such withdrawals are called loans, plan sponsors actually liquidate whatever the withdrawn money was invested in. If the market rises while you have the loan out, you will have to buy back in at the new higher prices.

Leaving a 401(k) intact is especially important, Edelman said, because "retirement is undeniably in your future, and unlike all other major expenses you incur, it must be prefunded." You can use a mortgage to help you pay for a house while you live in it, and repay student loans during your working life, but "if you divert money away from retirement funds, you are not going to be able to retire in the future."

To avoid tapping a retirement account for holiday purchases, consider automatic contributions to a savings account throughout the year. Making a choice to save for a goal far out in the future can be hard to sustain, so automating the process means you do not have to test your willpower on a regular basis.

Taft stressed the need for a financial plan based on goals so people can remain aware of why they are saving and thinking "planfully."

Edelman offers another, more drastic option.

"You need to rethink your entire approach to the holidays," he said. "You need to stop spending money on gifts for people who don't need them or want them, which you can't afford. You just need to stop the behavior."

That's a radical change, especially where making children happy is concerned. But it could significantly lighten next year's holiday hit to your wallet.