He could have dined out more often. He could have treated himself to a gym membership. He could have bought his first home.
Instead, 24-year-old Bodie Partsch said he did the responsible thing by investing a quarter of his income into his 401(k) retirement account. But now, with Wall Street seeing some of its biggest declines in years, Partsch's account is suffering and he's questioning his investment decisions.
If things get much worse, the Oregon man said, he might consider closing down the account entirely.
"I could have the money sitting in a jar on my kitchen counter. It'd be safer than in my 401(k)," he said.
It's the kind of thinking that makes financial planners cringe. They argue that taking money out of your 401(k) is almost never a good plan, even when the stock market is in the doldrums.
"It's such a bad idea," said Rick DeChaineau, owner of Secure Choice Financial Planning in Tacoma, Wash., and a member of the Garrett Planning Network whose members provide financial advice to clients on an hourly, as-needed basis. "There's very little upside. It's an option of very, very, very last resort."
Taking money out of your 401(k) account or stopping your contributions will deprive you of important tax benefits -- traditionally, income contributed to 401(k) accounts is not taxed -- and will hurt your retirement planning down the road, said Stuart Ritter, a certified financial planner with T. Rowe Price.
Market slumps notwithstanding, he said, the S&P 500 -- a broad composite index of large U.S.-based companies -- has consistently been higher at a given point in time than in the period 15 years prior.
"You need the growth stocks have historically provided to keep up with your rising expenses," Ritter said.
Even those nearing retirement shouldn't consider pulling out of the stock market entirely, he said. Many will still live 30 years beyond the traditional retirement age of 65. Some of the money that isn't spent immediately after retirement should remain invested, he said.
Risks of Taking Out Your Investments
If you are just nervous about the market and want to get out of stocks, every retirement plan offers relatively safe investments such as money market accounts. Moving money into those funds doesn't trigger any penalties, said Dean Kohmann, vice president of 401(k) Plan Services at Charles Schwab.
"People do make that mistake of trying to time the market by simply stepping out of the market," Kohmann said. "Retirement money is long-term money. If you're in your 30s, or 40s, or early 50s, you have a lot of years."
In the short term, withdrawing money from a 401(k) account before age 59 ½ -- known as a "hardship withdrawal" -- can open an investor up to steep penalties: Investors must pay a 10 percent federal penalty tax on the money they withdraw and must also have that money subject to income tax. For instance, if a person in the 25 percent tax bracket withdraws $50,000 from their 401(k) account, he or she will ultimately pay $17,500 in taxes on the withdrawal.
An investor willing to swallow the tax hit still must face significant hurdles before withdrawing money. Linda Wolohan of Vanguard said that, under rules set by the Internal Revenue Service, those who withdraw money early must exhaust other sources of funding before turning to their 401(k)s. Then, she said, they must prove that they need the money for one of five reasons: the purchase of a home or home repairs; medical bills; educational costs; funeral expenses; or warding off foreclosure or eviction.
These obstacles notwithstanding, T. Rowe Price has seen a 14 percent increase in hardship withdrawals in 2008. Fidelity Investments, the largest provider of retirement plans, saw a 7 percent increase in hardship withdrawals from April through June of this year.
Not everyone who has recently taken a withdrawal may have been aware of the tax penalties involved.
Massachusetts Secretary of the Commonwealth William Galvin is trying to temporarily suspend the 10 percent penalty for investors who sold in a panic.
Don't Dip into Your 401K
"These are unusual times and if we can be that forgiving to the investment banks of Wall Street, we need to show a little bit of consideration for working people," Galvin said.
His office has received numerous calls from worried investors who made such withdrawals -- and while he is sure they were warned of the consequences -- he still believes their judgment was clouded by fear of losing their entire savings.
"Over the last 20 years -- mostly by the slack of support for defined benefit pension plans and the encouragement provided by Congress -- we've encouraged working people to invest in 401(k)s and be responsible for their own financial futures," Galvin added. "At the same time we've given them a marketplace that has turned out to be anything but safe."
T. Rowe Price's Ritter said he's cheered by the fact that generally, customers with the firm have kept their contributions to their 401(k) plans steady and that the number of people taking loans from their retirement accounts has actually decreased by 4 percent. Fidelity, too, has seen a decrease in 401(k) plan loans.
Taking out loans is the more common way of getting cash from a 401(k) account. Unlike hardship withdrawals, investors who take out loans from their accounts don't face tax penalties.
But that doesn't make it a good idea, financial planners say.
Kohmann said such loans are really "a last resort."
"When you take that money out -- let's say the market does pick up -- you're going to lose out on the earnings in any upswing that the market experiences while you are paying back that loan," Kohmann said.
He said loans are repaid with after-tax money. The same money is then taxed again when you make withdrawals from the account.
"Essentially, you are getting double taxed for the money you are taking out for the loan," he said.
But there are more risks. If you decide to leave your company, or are fired, you are required to pay back that loan typically in 30 to 90 days. So, in this down economy, if you take out a loan, get fired and then can't repay it, the loan is treated as a withdrawal. You have to pay income tax on it, plus a 10 percent penalty.
Protect Your Retirement AccountThere is also another reason not to take out a loan if you are struggling to pay your bills. Retirement accounts such as 401(k)s are protected from creditors if you file for bankruptcy. If you borrow that money, it is not protected.
Schwab has seen volume at its call center double in the last two weeks but less than 10 percent of the callers have inquired about 401(k) plans and there has not been an increase in loan inquiries or requests.
Kohmann suggests that people call their investment company to get advice.
"We're not our own doctor, we're not our own mechanic and we shouldn't be our own investment adviser. Maybe the most important organ in investing is the stomach," he said. "Panic is not a strategy."