Wharton’s Olivia S. Mitchell talks with Wharton Business Daily on SiriusXM about the pitfalls of early withdrawals from retirement accounts.

As policymakers explore every option to get more money in the hands of people to help them cope during the pandemic, raiding retirement accounts is an easy target. Allowing people to withdraw from their 401(k) accounts without having to pay a penalty makes it easier to accomplish that objective, as permitted by the March 2020 CARES Act and the second stimulus bill of December 2020.

Those moves have reignited a familiar debate: Should penalty-free withdrawals from retirement accounts be encouraged or not? “It’s a terrible idea,” said Olivia S. Mitchell, executive director of the Pension Research Council at Wharton, in a recent interview on the Wharton Business Daily show on SiriusXM. (Listen to the podcast above.) Mitchell is also a professor of business, economics and public policy and professor of insurance and risk management at the School. She detailed her position in a recent Wall Street Journal article that also featured opposing ideas from Norbert J. Michel, director of the Heritage Foundation’s Center for Data Analysis.

Those considering early withdrawals from retirement accounts should be aware that they stand to lose “a big chunk” of their savings (including investment returns), by the time they are in their golden years, Mitchell said. Those early withdrawals are also a bad idea because the Social Security trust fund is expected to run out of money sooner than anticipated, perhaps by the end of this decade, she added. (Mitchell had worked on President George W. Bush’s Commission to Strengthen Social Security in 2001, where she offered a pathway to solvency for the trust fund.) A better option would be to take a loan from one’s retirement account, which carries relatively much lower interest rates than, say, credit cards, she noted.

Following are edited excerpts from the interview.

Wharton Business Daily: What are your thoughts on the move by Congress to allow people to be able to dip into their 401(k) accounts? You are not a fan of that idea in general.

Olivia Mitchell: That’s true. This got started in March 2020, when the CARES Act was passed by Congress, allowing people who had 401(k) accounts and who were younger than age 59.5 to access up to $100,000 from their retirement accounts without paying the 10% penalty. Congress permitted this in the throes of COVID and then they allowed the income taxes on those withdrawals to be spread over three years unless the money was repaid to the account. That option ended in December 2020.

Congress passed a new bill in December that did not extend penalty-free access to everyone, but it did permit people who experienced federally declared disasters, aside from COVID, to withdraw some of their 401(k) money. So, there are still eligible people who, in 2021, can withdraw up to $100,000 from their retirement accounts without penalties. Again, they can spread it over three years for tax purposes. In general, this is not a good idea.

“My concern is that if you let people raid their 401(k) or 403(b), they won’t understand the opportunity cost.” –Olivia S. Mitchell

WBD: In the Wall Street Journal article, Norbert Michel of the Heritage Foundation makes a case for permanently removing the 10% penalty on early withdrawals.

Mitchell: There are lots of bells and whistles around the retirement system. But [Michel’s] argument, if I may paraphrase it, is that it’s people’s money and they should be able to do what they want with it. My counter is that it’s actually tax-qualified money. It’s money that you don’t pay tax on until you withdraw it. For that reason, there really does need to be some thought about keeping the money in retirement accounts until later in life. People younger than 59.5 are probably not yet retired. That penalty is needed to remind people that it’s not a piggy bank.

WBD: Those savings for the future could run into the hundreds of thousands of dollars.

Mitchell: Quite so. In fact, in the Wall Street Journal article, I tried to make it very concrete. If a 40-year-old took out $50,000 from her retirement account today, by retirement at 67, she would have given up more than $223,000 in retirement assets with a reasonable rate of return (assuming an annual return of 5.7%). If you were to convert this into annual benefits, it would mean that she would have her retirement income reduced by $14,000 a year for the rest of her life. That is a painful cut.

WBD: You also noted the importance of having money in these funds, especially if Social Security is impacted significantly.

Mitchell: Yes, the Social Security Trust Fund has long been in trouble, and as we know now, the revenue coming in from payroll tax is inadequate to pay for benefits going out. The system is heading south quickly. [Some have said] that the trust fund may run out of money by the end of this decade.

That makes it even more imperative that people make provision for their own retirement. Taking money out of their 401(k)s now, despite the COVID pandemic, is the worst of the options. [In the Journal article], I also argued that there are many other options that people might have, though obviously there will be some who are jobless and can’t pay their mortgage. In that case, if it’s a dire emergency and there are no other options, obviously people must do what they need to survive. But it casts the retirement years under a pall.

WBD: You have long worried about this issue, going back even to the days when you worked with the Bush administration.

Mitchell: In the commentaries we received to the Wall Street Journal piece, some people argued that they would have preferred to keep their Social Security contributions themselves instead of giving them to the government. But the truth is that pretty much everybody retiring since the beginning of the system got back a lot more money than they put in. So, this perspective displays a lack of understanding about how the system works.

Financial Illiteracy

WBD: You also bring up the role of financial literacy in this argument.

Mitchell: A fundamental problem is that Americans are not terribly financially literate. We’ve surveyed people in their 50s and 60s, asking them three simple questions, which are now known as the Big Three. One is about interest rates, the second is about inflation, and the third is about stock market risk. Only one-third of Americans can answer all three questions correctly. (Mitchell’s recent research shows that financially literate people have been better able to handle the pandemic shock, as she said in the Journal article).

“The money you don’t see, you won’t spend.” –Olivia S. Mitchell

My concern is that if you let people raid their 401(k) or 403(b), they won’t understand the opportunity cost — the fact that they could be doing much better in retirement. They’ll spend it on who knows what — a vacation to Cancun or a bass boat — and then have to hold their hands out when they’re poor in old age. (The 401(k) plan is an employer-sponsored defined-contribution pension account, and 403(b) plans are only available to nonprofit organizations and government employers.) As a result, I see the sense in regulating access to tax-protected retirement accounts.

WBD: This is an important question right now because of the pandemic, but people are still trying to recoup the losses they suffered during the financial crisis in 2008 and 2009, right?

Mitchell: This is absolutely the case. Going into the pandemic, the country was not starting from a position of financial resilience and financial strength. Many people, if they can, will try to continue working even part time, if they can’t get a full-time job, until the economy picks up again. That is because their nest eggs simply aren’t going to be big enough to support them through their hopefully golden years.

WBD: Working longer allows people to be able to put more of a nest egg together for when they get to that retirement point.

Mitchell: It has always been said, and I agree, that the money you don’t see, you won’t spend. In fact, this is what’s always guided my own saving for retirement. On top of this, we have been reminded by the COVID pandemic that everyone needs to have an emergency or rainy-day fund.

The real concern here is that if people gain access to money in their retirement accounts, they may not be using it for the most high-priority items and will live to regret it in old age. I was talking the other day to the superintendent of pensions in Chile, where the government has permitted plan participants to take two withdrawals, and a third may be in the works. There, a majority of those who took their money were very young, which is problematic because they’re giving up the most; their money will not be able to grow over the long haul.

WBD: If you get into a situation where maybe the wallet is tight, then you need to look at the spending plan and see if you can cut back in some of those areas for a while – correct?

“Most of us don’t actually know where our money goes, so it is critical to track it.” –Olivia S. Mitchell

Mitchell: Clearly, not everybody has this flexibility. Nevertheless, most of us don’t actually know where our money goes, so it is critical to track it. Next, we need to carefully budget our spending, figure out what we can afford, and then try to cut whatever is not an absolute necessity.

For example, perhaps you could cancel extra TV subscriptions – difficult since what else is there to do during the pandemic except watch TV? Yet these are very expensive, and many of us should instead pay our medical bills, credit cards and mortgage.

WBD: Do you foresee structural changes to this process brought up by members of Congress anytime soon?

Mitchell: The first thing on the Biden Administration’s table is trying to get the next stimulus bill through. This will help prevent people needing to withdraw money from their retirement accounts, just as it has over the past year. If you’re really down and out, a better approach could be, if you’re still working, to borrow from your retirement account. Then you’ll be repaying yourself, the interest rate is usually rather low, and it’s not a permanent withdrawal from the 401(k) or the 403(b) account.

WBD: But I think the concern for some people is making that repayment and doing it in a timely fashion. Being able to put it back is a lot harder than maybe you actually think.

Mitchell: Retirement plan loans are automatically repaid through the employer payroll system, as long as you remain employed. And compared to the high interest rates on credit card bills of 29%-30% or more, this could make a big difference to your overall budget.