The Biggest Issue With Treating Your 401k as an ATM

The Wall Street Journal recently reported how frequently investors are tapping into their 401k well before their retirement date. They are using it like a personal ATM.

The known drawbacks include (i) paying taxes and an early withdrawal penalty on the amount (ii) reducing the amount that can compound in future years. But there is something more concerning. One is a fundamental financial issue, the other is psychological in nature.

The First Financial Damage

The first financial damage, which occurs before treating their retirement account like an ATM, is overextending oneself. Not living within a budget. Not being prudent with financial decisions. Not being a wise steward of assets. Engaging in unbridled consumption.

The Journal reports that, “Nearly 40% of those who took a hardship distribution last year did so to avoid foreclosure, compared with 36% in 2022.” How is this happening when most homeowners locked in all-time low mortgage rates? It is because they bought more house than they could afford. It is because they assumed the optimal, rather than the realistic.

Unbridled optimism can be just as damaging to oneself as pessimism. Acting based on desires alone. no matter how much we want it to be true, is foolish. We must act based on the realities of life. And in life, “stuff” happens. That is at the heart of financial planning. There would seldom be need to access the retirement ATM if financial decisions were prudent to begin with. Sometimes, such as an unexpected health crisis, things really do happen we can’t control. But far too many are taking withdrawals simply because they couldn’t discipline themselves earlier. And now they are paying for it…literally.

The Journal also reported, “A record share of 401(k) account holders took early withdrawals from their accounts last year for financial emergencies, according to internal data from Vanguard Group.” Why are so many people, “a record share,” accessing accounts for emergencies when the economy is strong and prosperity is plentiful? Unbridled and undisciplined consumption…perhaps we call it the first sin of financial stewardship.

The Psychological Damage

The psychological damage is real. Not because they feel bad about taking an early withdrawal and getting hit with penalties, but because spending is a behavior and they now see their nest egg as just another savings account (albeit with penalties). It’s like a drug; it only takes one time, and can be very difficult to stop.

We humans, in general, may struggle with personal accountability, but we are great at rationalizing our (poor) decisions. Once we rationalize one thing as an emergency or “essential”, it makes it easier to rationalize just about anything else our heart desires. We confuse want/desire with absolute need.

We must help investors view retirement accounts as completely off limits until the investor retires. The fact that other investors are using it as an ATM, and the media is reporting on it, makes taking early withdrawals more socially acceptable. This means we have to be even firmer and stronger in our language and warnings. We do not take out of retirement accounts unless we retire. And if they do it “just one time” don’t believe it. Most likely they will be back before long.

Proactively Discussing Hard Times

Many advisors don’t talk explicitly nor specifically enough about bad things happening. We talk about long-term performance assumptions, but not how much the account value could go down in the next 12 months. We talk about retirement and prosperity, without talking specifically about what the client would do if they are laid off or a significant financial burden befalls them. How will they survive?

Such discussions can lead to creating a robust emergency fund, discussions about family members they might be able to turn to for loans, credit cards, HELOCs, and other ways to obtain money that may not be desirable, but at least they don’t touch their retirement. And what would they tap first, second etc..?

Not having the hard discussions means we aren’t doing our job because life seldom goes perfect for anyone. Some of these points are not in the traditional financial planning software – they require the human to go deeper than the software. But that’s why they have you! Anyone can access financial planning software these days. What makes planning valuable, as always, is the human touch – the ability to go broader and deeper than a computer program, empathize with the client, and inspire them to do the hard (right) thing for their financial future.


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