Consider options before tapping 401(k) account

The Bakersfield Californian
January 25, 2013

As the Boomer generation ages, financial planners are concerned that people are not saving enough money to support themselves in retirement.

This concern escalated with recent reports that Boomers are digging their financial hole deeper by borrowing against their meager nest eggs.

Monitoring agencies report that more than one in four American workers with 401(k) and other retirement savings accounts use them to pay current expenses. They are tapping accounts through withdrawals and loans.

But it would be a cheap shot to paint these Boomers as free-spending, irresponsible jerks. Rather, they have been battered by the Great Recession, with many losing their jobs, or having their pay cut.

Until now, many Boomers felt financially secure because their employers provided defined-benefit pensions. In 1980, four out of five private-sector workers were covered by traditional pensions. But now, only one in five workers has such a benefit.

I often hear from financially-stressed clients who propose borrowing against their retirement savings. In fact, one came into my office last fall. I told my client, who I will call Stan, that such a loan should be a very last resort.

Generally, you can borrow $50,000 or half of the amount in your 401(k) – whichever amount is less. The advantages of such loans are that they are quick and easy. You don’t have to go through a lengthy application process or credit check. You repay the loan through paycheck withdrawals.

But the disadvantages are many. The loan must be paid off in five years; your retirement funds are reduced; and there may be tax implications.

Stan, 52, has worked for the same local company for several years. He is married and his wife worked part-time. One daughter recently married and he took out a $30,000 loan to pay for the wedding. The other daughter attended an out-of-state college and he helped with tuition and expenses. The couple bought a new home a few years ago and they owed more than its present value.

The family’s finances worsened when Stan’s recession-battered employer cut workers’ wages and hours. Bill collectors started calling.

Besides endangering his retirement, a 401(k) loan exposed Stan to a big risk.

Such loans must be paid off in five years. If Stan leaves his job or gets laid off, he will have to pay off the loan in one lump sum, or it will be reclassified an early withdrawal and he will have to pay penalties and taxes. Stan conceded that his job was not secure.

It was time to look for options: Borrowing elsewhere, cutting expenses, negotiating payment plans with creditors and increasing income.

That was nearly six months ago. Stan and his family are hopeful. And best yet, they are making their payments.

Stan picked up a second, part-time job. His wife increased her work hours to full-time. Their daughter moved home to attend a community college. They sold their house and are now renting. Their RV has been sold and discretionary spending cut.

Before grabbing “easy money” from retirement plans when you get into a financial bind, consult with a financial advisor, accountant or level-headed friends to find safer, smarter options.