Retirement Funds: The "Off Limits" Money

by Tom Allen and Mark Hebner - Wednesday, 28 December, 2016

Saving enough for retirement, let alone saving for retirement is a difficult endeavor for most investors. With the majority of baby boomers being underfunded for retirement, the overall conclusion that investors having enough knowledge, resources, and will power to prepare for retirement readiness is a farce. There are many reasons for this conclusion. Access to employer sponsored retirement plans, education on proper savings rates, and poor guidance for investors to follow in terms of investment advice have all led to our current situation.

Those of us who are still in the prime of our working years are learning from the previous generation and slowly catching on to the importance of seeking the right information for retirement readiness and to make changes to our behavior accordingly. But a large portion of the working population seems to be unable to keep the funds in our retirement accounts after we have already put them there.

Saving enough for retirement, let alone saving for retirement, is a difficult endeavor for most investors.

A recent 2016 Retirement Plan Participant Study from Natixis concludes that 28% of Americans are tapping into their retirement funds before retirement. There are many reasons for this behavior as well, which the study cites as being related to some sort of “financial hardship” like medical bills and paying down debt. Regardless of the circumstance, retirement funds should really be seen as the “off limits money” by investors.

There are 2 main reasons for this.

First has to deal with the simple accounting. We are essentially trading one personal financial liability for another. In other words, we are deciding to deal with our current financial hardship by creating another one down the road. Retirement readiness in and of itself is not going to fix itself and while investors may take the approach of dealing with the problem when they are eventually faced with it, it is often too late to do anything meaningful.

We always like to tell our clients that compound interest is the 8th wonder of the world, mainly driven by those who have a long time horizon. The problem with dealing with the problem once it is staring at them in the face is that there is no time. To give a simple example, $10,000 compounded over 30 years at an annualized rate of 8% yields just over $100,000. So somebody with a 30 year time horizon who decides to spend $10,000 of their retirement to deal with a current liability and no plans to replace the funds is really creating a $100,000 shortfall just from simple compound interest. The same person who decides to save $10,000 just 10 years out from retirement at the same 8% annualized return will only yield about $21,500. In other words, time is the fuel for making compound interest as powerful as it is in terms of retirement readiness. This is often why you hear many financial professionals tell young workers to start saving as early as they can.

The other main reason why investors shouldn’t tap into retirement funds before retirement to deal with short term financial hardship is because there are other financing options available, most of the time. The first is to start by creating an emergency cushion of 6-12 months of non-discretionary budget items such as rent, utilities, food, etc. Some tips and tricks to be able to accomplish that include eating out less often, making coffee at home, and even looking into cable and phone plans to see if there is a more viable option.

Second, is to tap into short term lines of credit to subsidize any remaining amount that you owe. Although the interest rates are generally unfavorable, it can provide a cushion as long as you plan on paying it off within the year.

We will say that, sometimes, the retirement plan is really the account of last resort because all other resources have been completely depleted. We understand that. Nonetheless, investors should try to set themselves up to be able to withstand short term financial shocks without sacrificing their future retirement readiness.