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Should You Borrow From Your Retirement Account to Make Ends Meet or Pay Debt?

Male thinking
Written by Steve Rhode

A couple of smarty-pants researchers at Ohio State University came out with a very interesting paper about people borrowing from their retirement accounts.

When facing money troubles it seems people are too often willing to rob from their retirement accounts to deal with an immediate financial threat. This is the classic definition of hyperbolic discounting.

Hyperbolic discounting is defined as “the tendency for people to increasingly choose a smaller-sooner reward over a larger-later reward as the delay occurs sooner rather than later in time.” – Source

The author’s note that the coronavirus pandemic created easier access to retirement funds without penalty through the 2020 Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Because of the emergency elimination of a withdrawal penalty, tapping the retirement accounts became an even more attractive source of “I need it now” money.

The CARES Act waives the early 10 percent penalty for retirement account withdrawals before 59.5 years old. It also raised the maximum withdrawal amount from $50,000 to $100,000.

But here is the problem, people making an emotional decision to rush now to withdraw money from their retirement accounts are often doing it with overconfidence and poor financial knowledge. And your level of financial knowledge has nothing to do with if you ever sat through and passed a financial education class.

Factors that influence your financial knowledge included demographic factors, your money personality (find out yours here), personality traits, and ideology.

Your financial IQ has nothing to do with your mental acuity. You can be book smart and financially dumb.

Retirement Facts are Shocking

As it stands now, about 40 percent of U.S. households with a household head between 35 and 64 years old are at risk of running out of money during retirement. And that’s only maintaining half the standard of living that they are now.

Can you imagine half of the people set to retire in the future are setting themselves up for being old, broke, and in poverty?

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Not All Early Retirement Withdrawls Are Silly

There are certainly times when an early withdrawal might make mathematical logic. For example, if you have limited assets and have found yourself in a dire situation, the retirement plan loan might be a logical option.

However, in the case of problem debt, there are ways to deal with tough money troubles without accessing creditor protected money that can be off-limits if you are sued over a delinquent debt.

I was talking with my debt coach friend Damon Day about this subject. It’s the kind of geeky debt conversations we have.

He brought up a good point and shared some practical experience. Day said, “When I’m helping people in financial trouble they often think the first thing they should do is reach into their retirement account to take money out. I often have to tell them to slow the bus down and let’s think this through.”

Day went on to say, “There have been many times when a client has felt the world is ending and they have to react to the debt problem. That is often not true. It’s just that clients don’t have the practical experience and are too close to the situation to make decisions based on reality and math.”

The authors of this research paper put it like this, They said, “Those who were overconfident were more likely to take hardship withdrawals and plan loans than otherwise similar non-overconfident individuals.”

They also said, “Some authors have suggested that financial education programs could be giving individuals false assurance of being financially literate and capable while they lack actual understanding of financial matters.”

That is an outcome I’ve observed as well. Just because you take a class, does not make you better at crisis financial choices.

The authors said, “Financial education programs should be carefully evaluated in terms of how they relate to both objective and subjective financial knowledge, to avoid simply boosting confidence while not improving actual knowledge, as overconfidence might lead to more detrimental outcomes.”

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For people that feel like taking the money from their retirement accounts is a smart thing to do, talking to a financial or debt professional and sense-checking the facts, is a smarter logical thing to do.

In closing, the authors concluded, “While early withdrawals definitely can have benefits, the costs and benefits need to be carefully weighed with a full understanding of financial consequences, especially with CARES act allowing easier access to retirement accounts.”

There is an old proverb about making sure you are doing the right thing. It is said you should measure twice and cut once to avoid wasting time and materials. The same can be said for checking the facts and realities before draining your retirement money.

Check twice and borrow once.




About the author

Steve Rhode

Steve Rhode is the Get Out of Debt Guy and has been helping good people with bad debt problems since 1994. You can learn more about Steve, here.

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