Spring Cleaning on your 401(k)

This time of year can be exciting and filled with new opportunities. This year, in between doing your Spring chores and your taxes, be sure to take time to sit down and evaluate your plans for retirement. When looking at your balance within your 401(k) it is common for people to think, “Wow, I could do a lot with that money now.” Maybe for you it is the thought of a nice vacation, a new car, upgrades on your house, or this seasons newest “must have” toys.  

Spring Fever can get the best of us if we are not careful. Thoughts of “I can afford to take a little from retirement” or “I can worry about saving later” tend to creep into our minds. I mean, what is the harm of just taking a little bit now? 

The risks of cashing out or borrowing from your 401(k) can be severe in the short-term, but devastating in the long-term. If someone is looking to cash out or take a distribution under the age of 59 ½, they can expect to pay a 10% penalty in addition to income tax. It is like stealing from yourself. In the long-term, however, consider this:

If you make $50K per year and contribute 5% of your income to your 401(k) - and receive a 4% match from your company – you would be able to save $4500 a year for retirement. Assuming, a contribution of $4500 per year and continued until age 65, with no changes in the dollar amount and assuming 8% compounding interest annually, then one can expect the following:

• Starting at age 25, you can accumulate over $1.3M at age 65.
• Starting at age 35 (or starting over), that total drops to just under $600K at age 65.
• Starting at age 45 (or starting over), the total now drops to around $245K at age 65.

As you can see, the short-term penalty is dwarfed by the long-term ramifications.

Some 401(k) plans allow participants to take loans and pay back themselves with interest through payroll deferrals. Every plan is different, but if loans are allowed, typically one can access up to $50K or 50% of their vested balance (whichever is lower). A loan will avoid the tax and penalty, but does not avoid the time missed in the market. Time is critical. 

Time is truly the only thing we can completely control in the market.

Using the previous example, the following is a good reference to assess the impact of time out of the market:

When assuming $4500 total contribution per year into a 401(k) with 8% compounding interest:

• It will take about 12 years to reach the first $100K
• It then takes about half that time to reach $200K (around 6 more years)
• It then takes about half that time to reach $300K (around 3 more years)
• In short, as the principal grows, the more compounding interest makes an impact

The main thing to consider is, when someone takes a loan from their 401(k), they are not contributing any more to their retirement, they are simply just paying themselves back. It is like hitting the pause button on your retirement savings for a few years. This time missed will significantly delay the ability to reach your financial goals.

Don’t let Spring Fever get the best of you. Before making any decisions on taking money from your retirement, make sure you understand the long-term effects. If you find yourself in a situation where this seems like the only option, find some help. I am always available at tyler@waypointus.com or by phone to answer any questions or help find alternative solutions.

Enjoy your Spring by saving for many seasons to come!

The examples used in this email are for illustrative purposes only.  Readers should consult with their CPA or other financial professionals before making financial decisions.

Warm Regard,

Tyler Campbell