It can be very easy to begin thinking about withdrawing money from your retirement accounts when unexpected events occur such as loss of employment or illness. It can be equally as tempting to withdraw funds from your accounts to purchase a new home or buy that dream car you have always wanted. However, if you want to retire and retire comfortably, the best thing to do is to access your other options if an unexpected event occurs and do not dip into the retirement savings if at all possible. Here’s why dipping into your savings can hinder you from retiring comfortably.
You lose the power of compound interest
Compound interest allows your investments to grow at astounding rates over time. When you remove money from your retirement accounts, you are essentially removing that money now and any “future” interest that money would have accrued if left in your account.
For example, if you have $80,000 in your retirement account and withdraw $10,000 (penalty-free) to purchase a home, your balance will now be $70,000. If the $70,000 is left in the account and earns an average of 7% for the next 20 years, the balance in your retirement account will be approximately $270,900. If the withdrawal was never made and the entire $80,000 is left in the account to earn compound interest, the balance in the account after 20 years will be approximately $309,600. That is a $28,700 difference when you take into account the $10,000 that was withdrawn!
Taking out a loan on your retirement account is not much better. Even though you will be paying yourself back with interest, you still lose the power of compound interest. Using the same scenario above, if you borrow $10,000 from your retirement account to buy your first home at a 6% interest rate, you will end up repaying a total of $13,322 over a 10 year term. If the same money was left in a retirement account and the stock market returned an average of 7% over 10 years, the balance in the account would be $14,203.
There are some scenarios where taking money out of your retirement account may be necessary, but if at all possible avoid the dreaded dip into retirement savings. As a rule of thumb, start an emergency fund to cover unexpected expenses. Aim to have enough funds in this account to cover 3 to 6 months’ worth of living expenses. If you want to buy a home or other larger purchase, set a monthly savings goal and practice delayed gratification until you reach your goal. If you can avoid dipping into your retirement account, you should be able to retire comfortably with less worry.