Think Twice Before Tapping Your 401(k) for Short-Term Needs

In extraordinary times like these, it is understandable that Americans need emergency cash injections to pay expenses. But before tapping their 401(k)s, workers should at least follow the advice offered by the old saying “think twice,” and consider all sources of short-term cash, before prematurely cashing out their 401(k) savings (WSJ: “The Emergency 401(k) Button,” March 20). Even if tax and other penalties on 401(k) cash-outs during this period are waived, Americans who cash out forfeit the additional savings which the sums they receive would have accrued by retirement, had they remained incubated in the U.S. retirement system.

Savers need to remember that the loss to their 401(k) savings from a cash-out is not only the small amount they withdraw today—it is the loss of years of compound interest and investment growth that won’t be there for their retirement years. Our research indicates a hypothetical 30-year-old who cashes out $5,000 in 401(k) savings today would lose up to $52,000 in earnings by age 65 (assuming account growth of 7% per year).

While waiving 401(k) cash-out penalties is well-intentioned, such a measure could end up hurting the very people it is meant to help by adding to our country’s already severe retirement-savings shortfall (estimated by the Employee Benefit Research Institute to be nearly $4 trillion for households headed by Americans aged 35 to 64).

We can borrow now, but we can’t borrow in retirement. If you are in need of short-term liquidity, the best thing you can do is borrow, wait for the universal basic income check in the mail, and try to avoid cashing out your 401(k). Your 70-year-old self will thank you for it.

WSJ Letter to Editor Published 3/27/2020