Scared of money being "locked away" in retirement accounts

Question

I have a reasonably comfortable emergency fund, some other savings, and some accounts I manage myself invested in stocks and funds. However I have only a minimal sum in pensions and retirement accounts.

I have noticed that these accounts often provide significant advantage including getting contributions from employers and advantageous tax treatment. However they also seem to almost always carry substantial penalties in the case of early withdrawal with certain exceptions.

I find myself greatly struggling to make myself put any money into these kinds of accounts due to the fear of these penalties, in case at some point in the future I need this money early. I tend to feel the money will be "locked away" and not real or accessible to me if I should need it.

Note I do not have trouble with spending too much, do not make sudden or large purchases and have little to no debt (have some credit cards for convenience but pay them off several times a month and never carry balance), and I save carefully a reasonable amount each month, living as frugally as I am reasonably able.

At some point in the future when I have sufficient savings I plan to buy a house, but am not entire clear when or how much that will cost. I also have various other somewhat unpredictable medical expenses that occur intermittently.

I am curious, is there a real issue behind my thinking here, that retirement accounts are indeed dangerous as if the money is needed suddenly the penalties could result in losses or at least poor gains? And if not, what would be the best way of working past the fear of having the money "locked away" in case it's needed as I realize I am paying significant capital gains and dividend taxes on these savings currently?

Answer 1

You can use a Roth IRA for retirement and you can still withdraw all of your contributions at any time. You can also withdraw $10,000 worth of the earnings in your Roth IRA for a first-time home purchase. You can also withdraw for unreimbursed medical expenses and qualified education expenses.

Full details are available in IRS publication 590.

There is a limit of $5,500 for contributions in 2016 ($6,500 if you're over 50) as long as your adjusted gross income is below a certain level. You can still make a contribution for the previous tax year until the filing deadline (usually April 15).

Answer 2

The alternative isn't too bad. Invest in a regular account. The dividends and cap gains will see favorable tax treatment. In my opinion, much of the magic of the retirement account is with 401(k) matched deposits.

The benefit you'll miss is the long term opportunity to skim income off the top, at say, 25%, have it grow, and then withdraw it at a much lower average tax rate. If that benefit doesn't outweigh the fear of the 10%, stick with my first thought above.

Answer 3

Yes, there are some real dangers in having your money locked into an investment. Those dangers are well worth thinking about and planning for. Where you are going off the rails is acting like those are the only dangers to your money, and perhaps having an exaggerated idea of the size of the dangers.

It is an excellent idea to keep an emergency fund with a few months living expenses in a readily accessible savings or checking account. However, a standard retail savings account is always going to pay less in interest then you are loosing through inflation. We're living in a low-inflation period, but it's still continuously eating away at the value of your savings. It makes sense to accept the danger of inflation for your emergency fund, but probably not for your retirement savings. To reduce the hazards of inflation, you need to find an investment that has some chance of paying more than the inflation rate. This is inevitably going to mean locking up your money for some period of time or accepting some other type of risk. There is no guaranteed safe path in the world. You can only do your best to understand the risks you are running.

As an example, you could put your savings in a CD rather than a vanilla savings account. A CD these days won't pay much in interest, but it will be more than a savings account. However, you have to commit to a term for the CD. If you take your money out early you will have to pay a penalty. How much of a penalty? In the worse case it could be in the neighborhood of 4% of the amount you withdraw. So, yeah if you deposit $10,000 in a 5-year CD and end up needing it all back the very next day, you could end up paying the bank $400.

If you withdraw money from a 401k before you are 59 1/2, you will pay a 10% penalty, and you will have to have income tax withheld on the amount you withdraw. On the other hand, if your employer matches 100% of your 401k contributions, you could be throwing away 50% of your possible retirement savings because of your fear of the possibility of a 10% loss! In addition 401k plans do have some exceptions to the early withdrawal penalty. There are provisions for medical emergencies and home purchases for example. However, the qualifications are not entirely straight-forward, and you should read up on them before enrolling.

The real answer to your fears is planning. Figure out your living expenses. Figure out how much you want in an emergency fund. Figure out when you will be wanting to buy a house, have a child, or go back to school. Set aside the savings you'll need for all those, and then for the remainder of your money you can consider long term investments with some confidence that you probably won't need to face the early withdrawal penalties.

Answer 4

Those advantages you've described (tax treatment and employee match) are what you receive in exchange for "locking up" the money. Ultimately it's a personal choice of whether that tradeoff makes sense for you situation (I'll echo the response that the real answer to your question is planning). Roth options (either 401K or IRA) may be good compromises for you, since you can withdraw those contributions (but not the earnings) without any penalty, since you've already paid taxes on them.

Another avenue to explore may be a self-directed IRA or a Solo 401(k), depending on your circumstances and eligibility. In both cases, there are plan providers that structure the plan to allow you to use the money to invest in things besides traditional stocks, bonds, and mutual funds (often referred to as "checkbook control" accounts). They are very commonly used among Real Estate investors (this thread from BiggerPockets has quite a bit of info). You'd want to consult with an accountant or financial adviser before going down that path.

Answer 5

While it’s your personal choice on HOW you save for later its essential that you save.

My sister works in a bank and recommended me not to put any money into retirement plans since the tax-advances seem fine but have to paid back when you take the money out of the accounts (in Switzerland, don't know about the united states).

Many reasons exist that you suddenly need the money: Buying a house, needing a new car, health issues or just leaving the country forever (and the government trying to make it as hard as possible for you to get your money back).

I recommend putting it on a savings account on a different bank that you normally use, without any cards and so on.

In short: It can be dangerous to have money locked away – especially if you could easily have it at your hands and you know you're able to manage it.