As has been widely reported, Americans have increasingly turned to their 401(k)s to fund emergency expenses. Of course, withdrawals before 59 ½ are subject to an additional 10% tax. As this Bloomberg story notes, the IRS collected $5.7 billion from the early withdrawal penalty, which means people withdrew $57 billion early.
As we have said before, 401(k) plans were actually never intended as retirement plans, but as savings plans. That’s why they allow distributions on hardship and for other purposes. So if 401(k)s are being used as more or less originally intended, why is this a problem?
First of all, it’s interesting behavior considering so many participants are concerned their 401(k) plans won’t be available to help fund their retirement, as we discussed previously. By withdrawing early, some participants are turning their fear into a self-fulfilling prophecy.
Additionally, as pensions have slowly (and mostly) faded to black, 401(k)s have become the dominant retirement planning vehicle. Thus, lawmakers and others have increasingly become concerned with so-called “leakage.” However, as this behavior shows, leakage is going to happen as long as it’s available.
So what’s the answer? The article makes this observation:
Congress, retirement experts and administration officials who are concerned about early withdrawals have two suggestions, totally at odds with each other: Lower the penalties or raise them.
Obviously, you can’t do both. Raising the penalties (or flatly