Personal Finance

Most young workers are using retirement accounts like an ATM

Key Points
  • In most cases, withdraws from your traditional IRA or 401(k) before age 59½ comes with a 10 percent early withdrawal penalty on top of regular income taxes.
  • When you tap your retirement savings, you also are removing the future earnings the amount would have generated, which can be sizable.

Financial advisors who beat the save-early-and-often drum might want to stifle their agonized groans.

To that point, 59 percent of investors ages 18 to 34 say they already have taken money from their retirement account, according to recent research by E-Trade Financial. 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.

Karl Tapales | Getty Images

Despite the prevalence of these early withdrawals, most younger investors (89 percent) are either somewhat or very confident that they will save enough to enjoy their retirement, the research shows.

They also should make sure they fully understand the impact of tapping retirement savings before age 59½. Early withdrawals from 401(k) plan 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, experts say. In other words, when you withdraw, for example, $10,000, you're taking out more than that amount — you also are eliminating all the potential 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 S&P 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 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 emergency23%13%3%
To pay for education22%16%3%
Because I became unemployed17%12%3%
To make a large purchase16%12%3%
To simply spend on myself/family13%6%1%
To spend on a vacation7%1%1%

Source: 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) plan 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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