Majority of young workers have already tapped their retirement savings

  • If you take money from your traditional IRA or 401(k) before age 59½, you'll pay income taxes and a 10 percent early withdrawal penalty unless you meet one of a few exclusions.
  • Tapping your nest egg early removes more than the amount you withdraw. It also eliminates all the interest and earnings that the amount would have earned over decades.

Many young retirement savers seem to be missing the point.

Nearly 60 percent of investors ages 18 to 34 say they already have taken money from their retirement account, according to research from E-Trade Financial being released today. That figure has been growing steadily since 2015, when it was 31 percent.

"There's a temptation to access retirement accounts, but it should be an option of last resort," said Mike Loewengart, vice president of investment strategy at E-Trade.

Some retirement savings plans bear little real fruit.
Karl Tapales | Getty Images
Some retirement savings plans bear little real fruit.

Millennials, the largest and most diverse generation in the workforce, generally face financial challenges that their parents did not as young adults.

On top of carrying most of the $1.4 trillion in student loan debt, their wages are lower than their parents' earnings when they were in their 20s: $40,581 in 2013 versus the inflation-adjusted $50,910 earned by baby boomers in 1989, according to a 2017 study by advocacy group Young Invincibles.

"There's no doubt that millennials face unique challenges," Loewengart said. "It's certainly worth recognizing, but it doesn't detract from the necessary steps to take to generate wealth."

One problem with tapping retirement money before age 59½ is that most of those distributions will generate a tax bill. Early withdrawals from 401(k) accounts and IRAs — excluding Roth versions of both — are subject not only to regular income taxes, but also a 10 percent early withdrawal penalty unless you meet one of a few exclusions.

On top of the potential tax cost, you're removing money intended to stay put so it can grow over several decades. In other words, when you take out, say, $10,000, you're removing more than that amount — you also are eliminating all the earnings and interest it would earn over several decades.

Those compounding gains are nothing to sneeze at. For illustration purposes: $10,000 invested in the Standard & Poor's 500 index in January 1988 would have grown to $211,900 by the end of 2017, according to MoneyChimp's online calculator.

Despite the consequences, many people who find themselves in a financial pinch turn to their retirement savings. The top reason cited for the withdrawal was for medical emergencies (23 percent), followed by education expenses (22 percent) and unemployment (17 percent).

Why people tap their 401(k)s early

Reason for early withdrawal
Under age 34
Ages 35-54
Age 55 & over
For a medical emergency 23% 13% 3%
To pay for education 22% 16% 3%
Because I became unemployed 17% 12% 3%
To make a large purchase 16% 12% 3%
To simply spend on myself/family 13% 6% 1%
To spend on a vacation 7% 1% 1%
Other 1% 3% 3%
Source: E*Trade's StreetWise quarterly study

However, 36 percent of workers who make early withdrawals do it to either make a big purchase, go on vacation or spend it on themselves or family.

"That's when it's about personal discipline," Loewengart said. "You have to be disciplined about your contributions during changing market environments and know the impact of compounding returns. If you're willing to take out the money for just any reason, you're jeopardizing your path to retirement."

Members of Generation X also are turning more often to their 401(k) for cash, with about 45 percent reporting having made early withdrawals. That's up from under 30 percent three years ago.

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