Fidelity released today that early retirement withdrawals are up big time in recent days where individuals are opting to pay a stiff penalty in order to gain access to retirement funds.  This is yet another example of the terrible financial condition of many, many Americans.

First, let’s look at how these folks got such a situation.  As we learned in Patrick’s post on the personal financial statement, most Americans are putting their capital into retirement and real estate and have too little liquidity in their lives.  The result is a complete lack of a cushion for hard times – when hard times hit, they have no cash on hand in order to meet expenses.

We can tie this situation to the fact that retirement funds (401(k)’s) and real estate have been pushed and incentivized now for some time here in America.  Think about it, there is both a tax incentive for both retirement accounts and owning real estate (via the mortgage interest deduction).  Unfortunately, at the same time there is a dis-incentive for savings – we are taxed of course on the interest we gain from savings.

These policies and habits by the American people have left them in quite a financial predicament.  The response is also the wrong one – early withdrawal of retirement funds.  Rather than make an adjustment in lifestyle and standard of living, folks are opting to pay a stiff penalty on their assets and accept less money just to continue their lifestyle.  This is a terrible path and of course, unsustainable.

The solution for these people is to:

• Accept a harsh standard of living adjustment until they can actually afford to get back to what they’re used to
• Keep their retirement accounts untouched
• Build up liquidity and cash reserves – 6 months of expenses or more
• Suspend contributions toward retirement until their financial situation improves

Of course, most people won’t follow this plan and the situation for most will deteriorate further and people will find themselves more and more broke.