Print

Email story

Comment

Letter to the editor

Borrowing against retirement accounts on the rise

More people are tapping into their 401(k) and IRA savings just to make ends meet.

By HELEN HUNTLEY, Personal Finance Editor
Published February 29, 2008

With their home equity tapped out, cash-strapped workers increasingly are raiding their retirement savings to stay afloat.

It's a decision that can have painful consequences when it's time to pay taxes and when retirement ultimately rolls around and there's less money to pay for it.

About 18 percent of all workers had retirement account loans outstanding in 2007, compared with 11 percent in 2006, according to an online consumer survey released Thursday by Transamerica Center for Retirement Studies. About half said they needed the loan to pay off debt.

Some retirement plan providers also say they have seen an uptick in loans and hardship withdrawals. An analysis of 350 retirement plans by JPMorgan Chase & Co. found 401k loans up 7 percent last year. At Vanguard, fewer plan participants took out loans last year (about 16 percent have a loan outstanding), but hardship withdrawals jumped 9 percent, to 1.5 percent of participants.

Retirement savings plans typically allow employees to borrow half their account balances up to $50,000. In addition, some plans allow hardship withdrawals, and workers who have left a company are free to cash out their retirement accounts there for any reason. However, all those approaches have serious tax consequences.

Withdrawals are always subject to regular income tax. In addition, a 10 percent penalty generally applies if you are younger than 59 1/2, unless you left the company at age 55 or older. Plans usually require a loan be paid off if you leave the company; if you fail to do that, it turns into a taxable withdrawal.

Many people withdraw retirement plan savings without understanding the tax impact, said Alison Painter, an Oldsmar CPA and financial planner. She said one of her clients withdrew $50,000 from his 401(k) last year and thought the $5,000 in taxes that the plan withheld would cover his liability.

"The $5,000 will cover the penalty, but not the taxes," she said. "He didn't think about what he was doing. ... Unfortunately, clients don't usually ask me in advance."

Home-equity loans and cash-out refinancings have been the preferred source of cash for emergencies and debt repayment. But falling prices and tighter lending standards have cut off access for many homeowners.

"If you have good credit, you can shop banks and credit card companies for good loan rates," Painter said. If you don't have good credit, retirement savings may be the only reasonably priced source of funds available, she said.

But Painter said people who are broke and out of other options should think twice about using retirement savings to pay off credit card debt that could be wiped out in bankruptcy. Retirement plans are protected from creditors.

Even if a retirement plan loan is repaid, it can have a negative impact on the account value if the interest rate is less than the market return the account would have earned on the money.

Helen Huntley can be reached at hhuntley@sptimes.com or (727) 893-8230.

Alternatives to borrowing from your retirement

- Mortgage refinancing or home-equity loan

- Brokerage firm loan using securities as collateral

- Bank or credit union loan secured by account balance or unsecured "signature" loan

- Credit card loan

[Last modified February 28, 2008, 22:56:57]