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2 reasons early super withdrawal might be a bad idea

One of the Federal Government’s policy responses to the coronavirus pandemic has been to allow the withdrawal of up to $20,000 from superannuation funds. Eligible persons are allowed to make one, tax-free withdrawal of $10,000 in the 2020 financial year, and a further $10,000 withdrawal in FY21 (which began last week on 1 July).

According to reporting in today’s Australian Financial Review (AFR), this program has proven remarkably popular. The AFR reports that the initial $27 billion in early withdrawals that Treasury forecasted is likely to be well exceeded.

Apparently, more than 2.4 million Australians have had early super release applications approved as of 5 July.

But there are many questions surrounding this policy decision. So let’s look at two of the main reasons I think withdrawing $10,000 or $20,000 from your super account might not be such a great idea. I’d like to preface this by saying that I’m not passing any judgement on those who have chosen to access their super early out of genuine financial hardship.

1) Early super withdrawal damages your retirement fund

The whole point of our superannuation structure is that it capitalises on compound interest over many decades. Making regular contributions to a pool of cash that is invested into growth assets like ASX shares is a great way to harness the power of compounding. It’s why investing $1,000 per month with a 7% return over 30 years will net you a nest egg of $1.23 million (excluding taxes and transaction fees). This is despite only $360,000 actually being invested over the period.

Unfortunately, a great way to kneecap these kinds of returns is withdrawing capital early. Withdrawing $10,000 today could cost you $50,000 down the road. It’s a high-cost transaction, have no doubt about it.

2) Most withdrawals were done at the market bottom

The first day Australians were eligible to access their super withdrawals was 20 April 2020. On that date, the S&P/ASX 200 Index (ASX: XJO) was down around 25% from its 2020 high watermark. In other words, most Aussies who cashed out their super did so after a massive share market crash. The ASX 200 has gone on to add nearly 11% since that date (plus some dividends). Unfortunately, these are gains anyone who cashed out some of their super missed out on.

It’s hard to quantify how damaging this action would have been for a retirement fund. Selling low is a great way to lose money, and it would have definitely stunted a super fund’s return potential if this was done in April.

For anyone who has made a second withdrawal over the past week, it’s not as deleterious due to the market’s more recent gains. But despite these gains, the ASX 200 still remains around 17% below its 2020 peak.

Foolish takeaway

As I said above, I’m certainly not trashing anyone who has withdrawn capital from their super fund out of genuine financial need. That was the intent of the scheme, afterall. But there have been disturbing reports that many Aussies are withdrawing this money to ‘play the markets’. Remember, our super funds are there to support our retirement. That’s not something I would want to undermine lightly.

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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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