7 Ways Money Leaks Out of Your 401(k)

These are the top reasons savers raid retirement accounts early.

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Most people who dip into their 401(k) or IRA before retirement aren’t buying the latest gadget or financing a lifestyle they can’t afford. Savers who take early retirement account withdrawals primarily have a compelling need for the money, such as job loss or a health problem, according to a new Urban Institute study. Some retirement investors also tap their nest egg to purchase a home. Those who raid their 401(k) shortly after a voluntary job change account for only 10 percent of total dollars withdrawn. Here’s a look at the seven most common reasons money leaks out of retirement accounts.

Job loss. Individuals who lose their jobs are 6.8 percentage points more likely to withdraw money from their retirement accounts than those who remain employed, even after other differences including age, education, and income are controlled for, according to the Urban Institute study of 16,853 adults ages 25 to 58 in 2004 with an IRA or 401(k). Among the 11.1 percent of adults who experienced a job loss over the course of the 2-year study, 15 percent withdrew from their retirement accounts compared with 7.7 percent of adults who were continuously employed. Job losses accounted for 12 percent of retirement savings dollars withdrawn during this period.

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Health problems. Savers who experience the onset of poor health are more likely than those who remain healthy to dip into their retirement stash. Withdrawal rates are 11.1 percent among those who develop a health problem compared to 8 percent among those who did not. Both 401(k)s and IRAs allow account holders penalty-free withdrawals for unreimbursed medical expenses that are more than 7.5 percent of their adjusted gross income. Individuals who become disabled to the point that they can no longer work can also avoid the early withdrawal penalty. The onset of disabilities explains 12 percent of all retirement early withdrawals, the Urban Institute found.

Job change. The probability of withdrawing from a 401(k) is 4.5 percentage points higher for adults who voluntarily change jobs than for those who stay put. Job hoppers who cash out their 401(k) make up 10 percent of all retirement savings withdrawals.

Home purchases. IRA account holders can withdraw up to $10,000 without penalty to purchase or build a first home. Couples who are both first-time home buyers can withdraw $20,000. Many home buyers appear to be taking advantage of this tax loophole. Adults who buy a home are 4 percentage points more likely to withdraw from their retirement accounts than those who do not. Home purchases accounted for 8 percent of the retirement savings leaked over the course of the study.

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Not having children. Surprisingly, having children is one of the few significant life events that doesn’t lead to tapping retirement accounts. The share of adults who withdrew money from their 401(k) or IRA is lower among those who experienced the birth of a child than for those who did not. Among the 7.2 percent of adults who added a new baby to their household, 5.9 percent withdrew cash from a retirement account compared to 8.5 percent of adults without a new child who raided a 401(k) or IRA. “A possible explanation for this finding might be that parents have many months to prepare for a baby,” write Urban Institute researchers Barbara Butrica, Sheila Zedlewski, and Philip Issa. “Therefore, the birth of a child has less of a shock on income than unexpected events such as a job loss or the onset of poor health.”

College costs. IRA accounts can be used without penalty to pay for college costs including tuition, fees, and books. However, most parents don’t appear to be using the savings in retirement accounts to pay for college. College expenses typically do not increase retirement account withdrawals, the study found. Higher education costs were the primary reason for 5 percent of retirement account withdrawals.

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Divorce or widowhood. Those who have recently divorced or widowed are generally not more likely to take retirement account withdrawals that those with no recent change in marital status, according to the Urban Institute. Changes in family status accounted for 2 percent of early 401(k) and IRA withdrawals.