Tapping retirement funds in emergency may cause other problems

The lack of emergency savings can cause financial problems far beyond a short-term cash crunch, new research shows.

Some people without cash reserves end up drawing on their retirement accounts, putting them at risk of shortfalls later in life, according to the Pew Charitable Trusts.

About 13 percent of working-age people with retirement accounts said they had drawn on their nest egg in the previous year and had suffered a financial setback, such as a major car repair or job loss, in the same period, Pew found.

The typical amount of the most expensive financial shock reported was $2,000.

The findings highlight the need for new ways to encourage people to save for unplanned financial jolts, said Alison Shelton, a senior research officer with Pew's retirement savings project.

"There's a need to help people save for the short term," she said.

The report is based on a new analysis of data from Pew's Survey of American Family Finances, focusing on Americans ages 20 to 58 who were not retired and did not have a retired spouse. (The survey, a representative sample of more than 5,600 households, was conducted in 2014 and 2015.)

People who withdraw money from certain retirement accounts like 401(k)s or individual retirement accounts before age 59½, the report noted, typically have to pay income taxes on the money as well as a 10 percent tax penalty.

Borrowing money from a 401(k), as some employers allow, can also dent the accumulation of retirement funds, because the worker loses any investment gains on the money that was borrowed.

As might be expected, people with lower incomes were more likely to draw on their retirement accounts. And the likelihood that workers would draw on their retirement funds increased as the size of the financial shock rose, relative to their monthly income.

Here are some questions and answers about emergency funds and retirement savings:

Q: Is it always a bad idea to borrow from my retirement account?

Q: How can I build emergency savings?

A: Michael Kalscheur, a senior financial consultant with Castle Wealth Advisors in Indianapolis, suggests working initially toward a goal that seems attainable — say, saving the equivalent of one paycheck.

While saving for retirement is important, consumers who lack liquid savings should consider whether they may be putting more into a retirement account than they can truly afford, Kalscheur said. One approach might be to put enough into your 401(k) to get your employer's matching contribution, he said, and then contribute cash to your emergency fund.

Once that reserve is built up, you can increase contributions to retirement savings.