Don’t sabotage your savings in order to pay the bills

Jean Chatzky TODAY Financial Editor • Profile • E-mail

The economy has left people behind on credit card bills, short on mortgage payments and low on cash to cover basics like gas and food. Those are gaps in the budget that have to be filled, and too often, people are raiding their 401(k) to come up with the extra money. If you're one of those thinking about it, I want you to stop, then keep reading.

When you pull money out of your 401(k) prematurely — in other words, before you reach age 59 1/2 — you're essentially robbing yourself. Not only do you have to pay taxes on the cash you pull out, but you'll also be hit with a penalty of 10 percent. It is rarely, if ever, worth it.

Let's take a 30-year-old who expects to retire at age 65. They have $20,000 in their 401(k). If they cash out, they're only going to take $12,000 of that money home because of taxes and penalties. That's $8,000 of your money, gone. But that's not even half the story. By pulling out, you're also passing up an opportunity for your money to grow. If left invested, that $20,000 could easily turn into upwards of $100,000 by the time you reach retirement age. The good news is that there are ways to come up with the money you need without sabotaging your future.

Balance your budget
I know, you've been over it with a fine-toothed comb and you simply can't find a place to cut back. But have you gone through the exercise of tracking your spending for a week or two? Cash often flies out of our pockets and we have no idea where it went. You go to the ATM, take out $20, and by the end of the day it's gone. This is where writing everything down helps, because you can look back and see that $3 went to a cup of coffee you could have made at home. Maybe you put $1 in the vending machine at work for a bag of chips, and that $10 bill was spent at the grocery store on a gallon of milk and a magazine. Eliminate the coffee and the chips, and you have an extra $4. Do it every day and you've saved close to $30 a week.
If tracking doesn't highlight any such discretionary spending, then you might need to consider taking on a part-time job for a while, or asking for a few overtime hours at work. I know it doesn't sound fun, but remember that it's a temporary — and often unavoidable — solution.

Scale back your contributions
I know the general advice is to contribute, contribute, contribute, but if you're feeling the squeeze, you need to take action. I'm giving you permission to slow your contributions to your 401(k) for a bit and redirect some of that money to your bills and other fixed expenses. The key words are: "for a bit." "People are creatures of inertia, and once you turn it off, it's a lot harder to go and turn it back on. You can always find excuses to spend the additional cash," warns Sri Reddy, head of retirement income strategies at ING. Don't let yourself fall into this trap. As soon as you're back on your feet, you need to get back on track with your retirement contributions as well.

Take out a loan
This is your last resort. If you have good credit and enough equity in your home, one option is a home equity. "A home equity loan is one of the lowest cost loans you can get, and you can still deduct the interest from your taxes in most situations," says Reddy.

Another option is to take a 401(k) loan instead of withdrawing the cash for good. A loan allows you to pull out a portion of your money when you need it and slowly pay it back to yourself, with interest. The downside? There are a few, actually. You're paying it back with after-tax dollars, which will then be taxed again when you start pulling the money out for retirement. If you leave your company, you'll likely be asked to pay it back in full inside of 60 days. And while your money is out of the market, you'll be missing out on any growth it would have otherwise experienced.

Roll your money into an IRA
Lastly, if you leave your job, leave your money in your previous employer's plan or do a rollover. You're not the only one struggling financially — small businesses and even the big

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corporations are having problems too, lay-offs are all too common. "If you're hit with a job cut, or even if you leave voluntarily, you have three options when it comes to your 401(k)," explains Spencer Williams, president and CEO of RolloverSystems, which helps companies and employees roll 401(k) money into IRA accounts. You can leave the money in your former employer's plan, have the company cut you a check for the account balance, or you can roll the money over into an IRA. If you take the check, you're going to face the taxes and penalties I mentioned earlier, a huge blow to your savings goals (to see exactly how huge, run the numbers on rolloversystems.com, which features a cash-out calculator to help you survey the damage.) Leaving your money with your former employer is not a bad option, particularly if you like your investment options. But the rollover is quick and easy, and puts you in the drivers seat as far as investing that money for the future. To start the ball rolling (so to speak), pick up the phone and call your plan administrator or human resources representative.

With reporting by Arielle McGowen

Jean Chatzky is an editor-at-large at Money Magazine and serves as AOL’s official Money Coach. She is the personal finance editor for NBC’s TODAY Show and is also a columnist for Life Magazine. She is the author of four books, including 2004’s “Pay it Down! From Debt to Wealth on $10 a Day” (Portfolio). To find out more, visit her Web site, www.jeanchatzky.com.

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