Most workers over 50 are dipping into their retirement accounts – here’s what to do instead of hacking your nest egg

Like a hammer from the sky, a $2,000 bill rolls into your checking account. You don’t have one, and your savings account is empty. So, where do you get the money?

One option: withdraw from your 401(k). It’s not a good option, but the money is there, and you can use it, despite the consequences – you wouldn’t be the first.

A recent report by LiveCareer (1) states that six out of ten workers over the age of 50 are withdrawing from retirement plans to meet day-to-day expenses.

Amid the rising cost of living, it’s tempting to dip into your retirement fund, but there’s a reason financial advisors advise against doing this. Early withdrawals from a 401(k) can cost you an additional 10% income tax on the amount you withdraw (2).

Fortunately, you can avoid early withdrawals from your 401(k) by doing a few simple things that can make paying for everyday expenses less expensive.

You may be putting too much money into your retirement accounts.

“I see a lot of people who are willing to shovel more money into their retirement accounts,” said Jay Abolofia, CFP, on CNBC Select (3). “I’m all for saving for retirement, but sometimes it’s a very good thing. You have to save somewhere else so you can adjust when life happens.”

If you have money in retirement accounts and nowhere else, rethink any current contributions. By building a modest emergency fund, you can avoid early withdrawal costs.

Even a small account can make a big difference. Vanguard found that savers with at least $2,000 in savings were 43 percent less likely to withdraw from a 401(k), and 17 percent less likely to make hardship withdrawals (4).

Pushing a pause in retirement contributions can be frustrating because it feels like you’re throwing away your future. But think of it this way – if your retirement plan is a car, an emergency fund is like car insurance: designed to be ignored 99% of the time, and if you need it, it will save you. A small emergency fund is just another part of your retirement savings.

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Use a checklist of non-retirement accounts you can withdraw without penalty. This includes HSAs, checking or savings accounts and taxable merchant accounts.

No money on hand? You still have options.

It can be cheaper to borrow money than withdraw funds from deposits. Personal loans can be very affordable, if you get a good rating. You may consider taking out a low-level home equity line of credit (HELOC) to pay off major expenses. That said, it’s a good idea to talk to a financial advisor before taking out a mortgage on your home.

Merrill Lynch suggests borrowing money from your 401(k) to avoid the worst penalties (5), although not all plans allow this. If your employer allows it, you may have to repay the entire loan if you leave the company. It’s not exactly ideal, but it’s probably a lot cheaper than dipping into your 401(k) early.

Avoid penalties by withdrawing contributions from a Roth IRA or using a special exemption.

Roth IRAs treat contributions and gains on those contributions differently. You can withdraw contributions to your Roth IRA without penalty, at any age, according to Fidelity Investments (6). However, gains are taxable and penalized if you withdraw them within five years of your initial contribution. So you need to be careful not to overpay.

In some cases, you can withdraw money from a 401(k) without penalty. The IRS lists special exemptions, including medical expenses and money needed to avoid eviction (7).

Thanks to the passage of the SECURE 2.0 Act of 2022 (8), you may be able to withdraw $1,000 from your 401(k) penalty-free, for a personal or family emergency. This is done once a year if you return the funds issued, or once after three years if you do not (9).

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LiveCareer (1); Internal Revenue Service (2),(7); CNBC (3),(8); Vanguard (4); Merrill Lynch (5); Fidelity Investments (6),(9)

This article first appeared on Moneywise.com under the headline: Most workers over 50 are dipping into their retirement accounts – here’s what to do instead of breaking into your nest egg.

This article provides information only and should not be construed as advice. Offered without warranty of any kind.