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Saving for retirement is critical – but there is such a thing as overdoing it.
Much like a “house poor” homeowner with a mortgage so high they’re cash-strapped, 401(k) poor is what happens when someone piles so much of their extra income into a retirement account that they have little savings or cushion in their monthly spending to cover emergency expenses.
That’s a bad position to be in, says Evan Farr, an elder law attorney and retirement planner based in Maryland.
“An example of this includes individuals who have a 401(k) worth $750,000, yet when confronted with a $30,000 expense related to a new roof, major medical expense, etc., there is no way they can afford these expenses without taking money out of their retirement accounts,” Farr wrote in an email.
The Independent explores how to strike that balance.
The major warning sign of being 401(k) poor is when an individual is forced to withdraw money from the account before retirement to cover the cost of an emergency or to pay off debt (Getty Images)
The benefit of 401(k)s
One of the reasons why 401(k)s are a popular retirement account is because employers typically match the employee’s contribution, up to a certain amount. For example, a company might match 100 percent of your contributions up to 5 percent of your paycheck.
Naturally, this may lead some people to want to pour as much money as they can into the account. In fact, the average person has $351,242 saved in their 401(k), according to a July study from financial services firm Empower. But the million-dollar account balances of those in their fifties and sixties skew this figure – in fact, 40 percent of Americans have no retirement savings at all, a Gallup survey found last year.
A 401(k) also has an added tax benefit. Any contributions made to the account reduce the individual’s taxable income, which makes it even more attractive as a savings destination.
Account holders can contribute up to $24,500 to their 401(k) in 2026, according to the Internal Revenue Service.
The sign of being 401(k) poor
The major warning sign of being 401(k) poor is when an individual is forced to withdraw money from the account before retirement to cover the cost of an emergency or to pay off debt.
In most cases, the IRS tacks on a 10 percent penalty to the withdrawal amount and counts it as taxable income.
In some cases, the withdrawal could push a taxpayer’s income into a higher tax bracket, meaning they pay a higher tax rate on their income.
“The costs associated with making an early withdrawal from a 401(k) account can be significant,” Farr said. “A $100,000 withdrawal could generate both ordinary federal and state income taxes and potentially an additional $10,000 penalty for early withdrawal.”
The IRS allows 401(k) loans of up to half of an account’s available balance or $50,000, whichever is less. That money isn’t taxable but borrowers have to pay interest on what they borrow. That means the prime rate (the base interest rate for borrowing) plus 1 percent or 2 percent, explains personal finance site Credible.
“Like other types of loans, you’ll repay a 401(k) loan over time with interest,” Credible points out. “Most plans require you to repay your loan in full within five years.”
For those who don’t have access to cash but don’t want to withdraw from their 401(k), they are left with borrowing options like credit cards with high interest rates or personal loans.
How to save wisely for retirement
One simple step will stop you becoming 401(k) poor, and rather see your retirement savings put you in a position of wealth.
Set up an emergency fund – a savings account intended to cover unexpected expenses such as a pricey car repair, surprise hospital bill or job loss.
“Setting up a dedicated savings or emergency fund is one essential way to protect yourself, and it’s one of the first steps you can take to start saving,” the Consumer Financial Protection Bureau writes.
An emergency fund is meant to be a liquid cash account – you can pull money out of it when needed without paying a penalty or taxes, in most cases.
Knowing how much to put into an emergency fund is different for everyone.
“Think about the most common kind of unexpected expenses you’ve had in the past and how much they cost,” the bureau says. “This may help you set a goal for how much you want to have set aside.”
Once an individual has a number in mind – say, $5,000 – setting up automatic transfers from checking to the emergency fund account makes the savings process easy. If an expense pops up during the saving process, pay from the account and then replenish it.
Another way to fill an emergency fund is by sending cash windfalls to the account.
“For many Americans, a tax refund can be one of the largest checks they receive all year,” the Consumer Financial Protection Bureau says. “There may be other times of the year, like a holiday or birthday, that you receive a cash gift. While it’s tempting to spend it, saving all or a portion of that money could help you quickly set up your emergency fund.”