Retirement is the prize at the end of the work marathon. Any financial advisor or accountant will tell you it’s a good idea to start saving for retirement as early as possible, and the average working adult spends decades adding money, little by little, to his or her retirement fund. When the time comes, that money will be spent on leisure, fun, and everything else we can’t do while working full time.
Now, you’re not supposed to touch any of the money in your retirement account until the time is right, but countless people end up dipping into their savings long before retiring. An interesting new study from The University of Michigan and the University of Delaware looked into the top reasons why people make early withdrawals from their retirement funds and concluded that divorce is the most frequent motivator. Besides divorce, mortgage payments are another super common reason for early withdrawals.
More specifically, the research team found that Americans are most likely to withdraw savings before retirement during divorce proceedings or immediately following the loss of a job.
Decades ago, most Americans’ retirement funds were tied up in employer-funded pensions, but as of 2015, the majority of working adults have retirement funds known as “defined contribution” accounts, such as IRAs or 401(k)s. These defined contribution accounts are much more flexible, and allow withdrawals at any time.
“These plans, now the dominant form of U.S. pensions, also provide pre-retirement liquidity features,” explains Frank Stafford, professor of economics and research professor at U-M’s Institute for Social Research, in a university release. “Increasingly, retirement savings are being used to finance current consumption, notably during periods of income decline. Further, most employers allow participants to discontinue their contributions to realize a greater current cash flow.”
It doesn’t have to necessarily be withdrawals either. If an individual was contributing $700 per month to their retirement account before starting divorce proceedings, they may decide to cut that monthly allotment in half ($350) while dealing with the separation.
According to the research, divorced households are 9.5% more likely to access their retirement savings early, and 11.8% less likely to keep up with retirement contributions. Meanwhile, losing one’s job makes that person 3.5% more likely to “cash-out” their savings.
The potential influence of medical expenses on premature retirement spending was also estimated. A 10% increase in out-of-pocket medical spending is believed to increase one’s odds of accessing their retirement funds early by .6%. However, that percentage may be higher right now due to the COVID-19 pandemic.
“From our work, we expect to see heavy access to pre-retirement pension balances, and ceasing to participate in contributing to pension in response to the economic impacts of coronavirus,” Stafford says. “We also expect to see lower incomes, housing payment problems, family dissolution, and divorce.”
The study’s estimations are primarily based on the aforementioned shift over the past 15-20 years from employer-funded pensions to defined contribution pensions.
“This shift resulted in a greater share of households with access to liquid retirement savings, as well as a greater share of households whose retirement security depends on voluntary contributions,” Stafford comments.
Data originally collected for the Panel Study of Income Dynamics (PSID) was used for this research. The PSID had tracked the financial activity of a group of families and their descendants since 1968 and started tracking retirement allocations in 1999. So, the research team examined wealth and pension data for 1999-2015 and then refined their analysis to only married households between the ages of 25-64. Those households didn’t have to necessarily stay married, though.
Somewhat predictably, they noted that the older a household or individual is, the more likely they are to access their retirement funds early. For example, 62-64-year-olds are the most likely age group to make an early withdrawal, followed by 59-61-year-olds and 44-58-year-olds.
Another finding of note, the study’s authors found no evidence that homeowners are dipping into their retirement savings just to make superfluous changes or improvements to their homes, or any other extravagant purchases for that matter. This indicates at least a certain degree of financial responsibility.
On that note, the data suggests that households making big purchases are more likely to keep contributing to their retirement funds. For instance, individuals who received an inheritance or windfall of over $10,000 were 4% more likely to keep putting money aside for retirement.
“There is the short-term benefit of greater liquidity through reducing contributions to, or withdrawing cash from, retirement resources, and this liquidity feature may substantially benefit constrained households,” Stafford concludes. “Of concern, however, is the effect of repeated use of these more flexible retirement account saving features on longer-term savings adequacy. This warrants further study.”
Everyone’s financial situation, and life, is unique. Whether or not it’s a good idea to withdraw from a retirement account early depends entirely on the individual. No matter what, though, it’s a good idea to view such an action as a last resort. It may feel like it’s a long way away, but the day will come when you wake up retired. When that happens, you’ll be happy you didn’t empty your savings decades earlier.
John Anderer is a frequent contributor to Ladders News.