Why Your Retirement Fund Isn’t an Emergency Fund

Mark and Sherry knew retirement was important. Both of them had seen their parents struggle financially, and they were determined to forge a different path. They’d set aside a percentage of their paychecks to invest in a 401(k) program offered by each one’s company. They’d even worked with an advisor to pick mutual funds that matched their goals and risk tolerance. Everything was rolling along great.

And then life interrupted their plans.

Sherry was in a car accident. She ended up in the ER and her car ended up in the junkyard. Her injuries kept her from working for several months, so they lost half of their income. Now they’re facing a mountain of hospital bills, student loans and credit card bills. Fear and anxiety started creeping into the corners of their minds. They wondered how they could pay all of these bills when they could barely make ends meet.

In a moment of weakness, the couple decided that the only way to get out of the hole was to raid their retirement fund. They knew Sherry would be back to work soon and they could begin putting the money back where it belonged. It seemed like the only option.

Don’t Touch Your Retirement!

Unfortunately, this story is all too common. If you’re thinking about taking money from your retirement fund to deal with unexpected expenses, then think again. Here are few reasons you don’t want to do that.

1. You’ll Pay Huge Penalties

Most traditional 401(k) programs slap you with a 10% early withdrawal penalty—and that’s on top of the income tax you pay when you take it out. (Remember, money invested in a 401(k) isn’t taxed until you withdraw it.) If you take out $10,000 to cover expenses from the wreck, you’re already down $1,000. Not a good idea.

2. You’ll Pay Interest

Some 401(k) programs will allow you to borrow against the amount in your account. But it’s a loan, and a loan means interest paid instead of received. And if you don’t pay off the loan in time, it’s treated like a withdrawal—which means penalties and taxes.

3. You’re Robbing Yourself

Taking money out might not seem like a big deal because you’re going to repay it, right? The problem is that you’ve robbed yourself of time (however long it takes you to pay it back) and the interest you could have earned on that money. Compounded over 20 years, that interest is a big deal!

4. Life Happens

You may have every intention of paying back the 401(k), but what happens if you hit another roadblock? That’s the problem with the unexpected—there are no warning signals to help you prepare. You may not be able to refund your account—and that only makes matters worse.

What Raiding Your Retirement Reveals

Pulling money from your 401(k) to pay for emergencies is putting a Band-Aid on the real problem when you need to do major surgery. Mark and Sherry found themselves in a heap of trouble because they were living paycheck to paycheck and had no money saved for emergencies. And that’s how too many of us live. It’s the new American nightmare.

Mark and Sherry’s Solution—And Yours

Mark and Sherry needed to fundamentally change how they handled money. They had to get serious about getting out of debt and making their money work for them. That meant temporarily pausing on their 401(k) contributions, getting on a budget (and following it!), working extra jobs, and using the debt snowball to tackle their bills one at a time. Then they could save three to six months’ worth of expenses so they wouldn’t ever be caught off guard again. That would free them up to throw everything they could at their retirement fund—with the peace of mind that they’d never make the same mistake twice.

And if you make smart money decisions, you won’t have to make their mistake at all.