This common Gen X financial move could make retirement that much more difficult

Each generation has its own challenges when it comes to saving for retirement. For Gen Xers, the demise of pension plans has left them self-funding more of their retirement costs than previous generations. Many also found themselves between grown children who still need support and elderly parents who need help with basic tasks.

Like everyone, Gen Xers must balance their future financial needs with their current ones, and this is not always easy. Everyone deals with it in their own way, but Gen Xers are more likely than other generations to use a strategy that makes saving enough for retirement a much more difficult task.

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Retirement savings are for retirement

Ideally, when you put money into a retirement account, you’ll leave it there until you need it to cover your retirement costs. But this is not a requirement. Most retirement accounts allow you to withdraw your funds, although there is often a 10% early withdrawal penalty for doing so. You may also have to pay income tax on your withdrawal if it comes from a tax-deferred account.

The disadvantages of this are quite obvious. You lose a substantial part of your savings and you will also face a higher tax today. So it’s usually a last resort for workers who need some extra cash.

Some — including about one in four Gen X workers, according to Fidelity — are opting for 401(k) loans instead. Borrow money from your 401(k) instead of taking a distribution. As long as you pay the loan back with interest over time, you won’t face income taxes or early withdrawal penalties. You also pay your interest back rather than to another lender.

But 401(k) loans also have their drawbacks. First, you’re limited to either $50,000 or half of your granted balance — whichever is less — so you can’t withdraw as much as you want. Second, if you leave your job, the loan balance may fall due, forcing you to either pay a significant lump sum or pay taxes on the outstanding amount.

The biggest downside, however, is the same problem with taking an early withdrawal from your retirement account. Your money is no longer invested, so it cannot grow for your future. And the interest you pay back on the loan will likely be less than you would have earned if you had left the money untouched.

As a result, you will need to save more money in the future to reach your savings goal. If this is not feasible, you may have to delay retirement longer than you intended. That’s not to say it’s always the wrong choice, but it’s definitely worth exploring other options before taking out a 401(k) loan.

Alternatives to a 401(k) Loan.

First, it’s always worth checking to see if you can cover your expenses without touching your retirement funds. You can use an emergency fund for unplanned expenses if you have one. You may also be able to take out a traditional loan for some property, such as a car. However, your credit score will affect whether you get approved and what kind of loan terms you get.

If you don’t need to make an immediate purchase, consider saving up for it over time. Set up automatic transfers to a savings account, if possible, so you don’t have to remember to make these contributions yourself.

When you need to tap into your retirement savings, first check to see if a 401(k) loan is even an option. Not all plans allow them. If you are allowed, weigh its pros and cons against other types of retirement withdrawals.

Some retirement plans offer exceptions to the early withdrawal penalty for things like large medical expenses or a first home purchase. Additionally, Roth IRAs allow for tax-free withdrawals of contributions at each age. However, this does not apply to winnings. Similarly, you can make tax-free medical withdrawals from health savings accounts (HSAs) at any age if you’re trying to pay a hospital bill.

You may still decide that a 401(k) loan is the best option. If so, talk to your plan administrator to make sure you understand the terms of the loan, when you’re expected to make payments, and what happens if you and your employer separate. Make sure you are comfortable with these details before taking out the loan.