Should 401(k) Withdrawals Be Easier?

Deciding to withdraw money from your 401(k) “early”-before age 59½-is something that many financial advisors find appealing.

Don’t leave with eggs in your nest, they preach. And with good reason. The government usually imposes a 10% penalty for early withdrawals. And you lose any investment gains you may have made on the money you withdrew.

But is it really so wrong to take money out of your account (whether it’s a withdrawal or a simple loan) when you need it? Is it better to suffer when you need money and perhaps charge your credit card while your 401(k) is inactive?

Last year, through Covid-19 and the closures, we saw the experience unfold across the country. Congress authorized cash withdrawals from 401(k)s and IRAs for those affected by Covid, up to $100,000 without a 10% penalty. Some have called him a savior. In the end, a limited number of people withdrew cash – such as 6.3 percent of participants from Fidelity Investments, the country’s largest 401(k) provider, and 5.7 percent from the Vanguard Group.

As the market grew, many were able to quickly replenish their accounts, at least in part. The money they withdrew, of course, did not benefit them.

So our debate is this: should this experiment make it easier to withdraw money from accounts if people accept that these accounts are duplicates of emergency funds? Or should people be discouraged from looting retirement funds?

Norbert J. Michel, director of the Heritage Foundation’s data analysis center, believes that the people should decide their own money, not Congress, and that the 10% penalty should be eliminated forever. Olivia S. Mitchell, director of the Retirement Research Council at the Wharton School of the University of Pennsylvania, writes that early retirement is financially harmful.

YES: Let people decide how to use their savings.

Norbert J. Michel.

The Covid pandemic demonstrated the critical importance of saving people when they face unexpected circumstances. But often some of people’s savings are tied up in retirement accounts due to financial regulations.

That needs to change. It is the people going through hard times who should decide when and how best to use their retirement savings, not members of Congress. We need to permanently eliminate the 10% penalty for early withdrawals.

Setting aside money for retirement is important, but using some of that money before retirement – for example, to avoid an eviction, pay off debt or fix your car to get to work – may be better than saving it. Congress should allow people to invest and withdraw their savings for any reason, at any time and without restrictions. People need more economic freedom and less paternalism from governments.

The prevailing view is that people will throw their money away unless they face withdrawal restrictions, leaving Congress no choice but to raise taxes to support the rising tide of impoverished seniors on Social Security.

But these restrictions are an insult to the intelligence and integrity of millions of people. These rules are based on the assumption that people are incapable of understanding their own situation and interests, as well as basic financial concepts. This is condescending and wrong.

Consider this: When Congress eliminated the early withdrawal penalty last year, relatively few people chose to use their retirement funds. Savers seem more reluctant than lawmakers, and advocates agree.

Plenty of time.

It is true that people can forgo income from their retirement accounts after early withdrawal. Some critics say the consequences of this could lead to people being forced to work much longer than they expected. So the logic is that instead of allowing people to withdraw the money earlier, they should be forced to do things like use lines of credit against the equity in their home or reduce their spending.

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But it’s possible that the new rules allowing people to put as much money into retirement accounts as they want could encourage them to put more money into their plans after they withdraw money. And that could allow them to do more than just make up for losses.

As for the proposed alternatives to withdrawal, it is far better to let people assess the risks and decide for their own money, rather than tell them what they can do.

Social Security is a good example of what can go wrong with government regulations on retirement planning – it is steroid paternalism.

With Social Security, the government tries to provide people with money when they retire by telling them how to save. But it’s a much worse deal for workers than letting them manage their own money. Social Security benefits are relatively lower than private savings accounts, and people who die before they retire or take early retirement lose all the money they have contributed (and, of course, the money they have invested is not primarily for themselves, since their contributions actually benefit other retirees).

If people could keep their own Social Security contributions, these two problems would at least be alleviated. And because people could manage their own money, they would have an incentive to save more than they otherwise would. For the same reason that people are reluctant to take non-refundable flights, many are reluctant to tie up their savings in restricted retirement accounts.

individual freedom

It is understandable that we have a moral obligation to help others retire. But it does not follow that giving government the power to appropriate individual freedoms is the best way to do things. In a free market system, people develop ideas and start businesses to help others because it makes them profitable – like developing an application to help people track and manage their savings.

In Canada and the United Kingdom, unlimited retirement accounts actually force people to save more, with low-wage and younger workers taking advantage of these opportunities in particular.

This data contradicts the idea that people would not be able to acquire basic financial skills and save for themselves. Moreover, it shows how federal paternalism prevents Americans from becoming financially secure and moving up the economic ladder.

People don’t need government regulations telling them what is socially acceptable time or a way to spend their savings.

Dr. Michel is director of the Data Analysis Center at the Heritage Foundation. He can be reached at [email protected].

NO: Early withdrawal of funds is financially detrimental.

Olivia S. Mitchell.

Lawmakers are wrong to facilitate early withdrawals from pension plans. It would put many people in a difficult financial situation and send them into retirement unprepared.


If you withdraw money from retirement early, that money has no chance of earning you back at your retirement date. For example, if a 40-year-old withdraws $50,000 from her account today, by the time she retires at age 67 she will have lost more than $223,000 in retirement savings, assuming a modest annual rate of return of 5.7%. This reduces her retirement income by about $14,000 per year for the rest of her life.

The opportunity cost is even higher when the stock market is booming, as it has been recently. People who withdrew money from their accounts when the rules were relaxed last year have missed the opportunity to put more money in their accounts during this sharp rise.

Serious consequences

All these lost returns have serious consequences. For example, people may have to work another 10 years to make up for the depletion of their retirement accounts.

This possibility could worsen very soon, since the social security system will probably run out of money in ten years. Therefore, it is all the more important that people increase their savings for their own retirement rather than withdrawing money prematurely.

Finally, remember that retirement accounts are legally protected from most bankruptcies, but once the money is withdrawn, it becomes subject to liens and judgments. Even in a financial emergency, you should protect your retirement savings.

Some advocates of lower withdrawal limits believe that it is paternalistic to put decisions beyond people’s control. People should be able to manage their money as they see fit, say Social Security advocates, using Social Security as an example of a failing system: if people had control over their own withdrawals, they would get better returns and contribute more to their retirement.

But that doesn’t work in the real world. Since Social Security is a pay-as-you-go system, there is no immediate way to switch to a private account system because social security contributions are now used to support retirees. My work on President Bush’s Commission to Strengthen Social Security in 2001 suggested a path to solvency that included a private account for some of the contributions, but this was possible at a time when the system’s revenues exceeded its costs – and that is no longer the case.

Moreover, whether they like it or not, many Americans suffer from staggering financial illiteracy, which means it will take a huge investment in education to get people to plan, save and invest properly. Right now, we are a long way from that. There may be a few exceptions, but most countries have limits, showing that they are aware of the dangers of not having them.

But the main argument of the critics is that thousands, if not millions, of people are in serious financial difficulties and that exit would be an ideal solution to their situation.

But there are many things people can do that go beyond the termination benefits of the retirement plan and are in addition to their tax-deferred contributions and investment income.

For example, if you work for a company where you have made contributions to an employer-provided retirement account, find out if you can borrow under that plan. These loans are usually much cheaper and easier to take out without affecting your credit history. However, this is not an ideal solution: these loans must be repaid, and if you lose your job, the full amount must be repaid within a short period of time. You can also explore other sources of money that may be suitable for you, such as home equity loans. If you are having trouble repaying your student loans, there is a long list of programs that offer help and forgiveness. In addition, people who have too many high-interest credit cards may benefit from card consolidation and a debt management plan.

Expenditure side

It is equally important to scrutinize your spending plan and budget to make sure they hold up during the pandemic and beyond. Make a list of all your expenses and cross out anything that is not absolutely necessary.

It may include additional cell phone services, gym memberships, special TV subscriptions and take-home meals if you can prepare them yourself more cheaply. If you don’t drive as much as you did before the pandemic, find cheaper car insurance that only charges for miles driven. Postpone your vacation (if you plan one!).

Last but not least, obtain as much information as possible. Financial education is an important factor in protecting people from financial instability. In fact, my recent research shows that financially educated people are more resilient to a pandemic shock, confirming that knowledge makes for greater resilience in difficult times.

Dr. Mitchell is director of the Retirement Research Council at the Wharton School of the University of Pennsylvania. She can be reached at [email protected].

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Frequently asked questions

Is it a good idea to get out of a 401k?

In general, it is not advisable to make…. early withdrawals from your 401K. However, in certain cases, such as financial hardship or early retirement, early withdrawals (or distributions) from your 401K may be a wise strategy.

Is it better to take out a 401k loan or withdraw money from the account?

Benefits: Unlike 401(k) withdrawals, you don’t have to pay taxes or penalties when you take out a 401(k) loan. … You also lose the ability to invest the borrowed money in a tax-deferred account, missing out on growth potential that could be greater than the interest you pay back to yourself.

Why is it so hard to give up a 401k?

In general, it is difficult to withdraw money from a 401k account. This is part of the cost of a 401k plan – a kind of imposed discipline that forces you to leave your savings alone until retirement, or face significant penalties.

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