Avoid Using Retirement Funds to Make Ends Meet

Suzanna De Baca -- Expert Business Source, 9/3/2008 11:57:00 AM

Are you feeling the crunch of the economy more than ever?  Have you been eyeing your retirement account, thinking these funds might be the way to pay your credit card or mortgage bill?  While dipping into your 401(k) or IRA might seem like the solution to your current fiscal woes, consider using this incredibly important asset only as a last resort. 

Unfortunately, more and more Americans are tapping into their retirement accounts in order to make ends meet during this challenging economic period. I wrote about this phenomenon in May, (“Bad Economy? Try Not to Dip into Retirement Funds.”) but just a few months later new data from some of the foremost 401(k) plan administrators show that withdrawals have continued to increase significantly at a rapid rate.

According to a September 2, 2008, Washington Post article by Nancy Trejos entitled “Using Nest Eggs Before Maturity,” leading fund family T. Rowe Price reported that withdrawals from 401(k) plans were up 19 percent in June compared to the same time during the prior year.  Trejos goes on to write that Vanguard’s withdrawals increased 8.6 percent in 2007 from the year before and that Hewitt Associates, which tracks 401(k) trends, has reported that hardship withdrawals have increased across the nation.

Using your 401(k) prematurely has a number of negative consequences and this option should be weighed very carefully.  In fact, not all employers even allow withdrawals.  Those who do generally allow loans or hardship withdrawals.  If you want to tap into your 401(k) prior to age 59 ½, you have a number of options, but most of them come with hefty penalties or payments of one sort or another. 

To take a hardship withdrawals, one must prove extreme financial need. In a June 6, 2008 article entitled “More dip early into funds for retirement: Hardship withdrawals can cause long-term jeapordy,” Boston Globe writer Ross Kerber outlines several drawbacks to taking hardship withdrawals.  Kerber writes that unexpected downside of taking a hardship withdrawal “is that the money is counted as part of an employee’s gross income, increasing the amount subject to taxation, putting the employee in a higher tax bracket.”  Ouch.

You may be worse off taking a hardship loan if you’re trying to stave off creditors.  In generally, 401(k) plans are safe from creditors, but by taking a withdrawal those funds –or the assets you’re trying to protect – are not protected anymore. 

And a loan?  Well, a loan is a loan. You have to pay it back, and even with your own 401(k), you’ll owe interest.  According to the Department of Labor Employee Benefits Security Administration, if an individual takes a loan from his or her 401(k), the “loans must charge a reasonable rate of interest and be adequately secured.”  If you borrow from your 401(k), you typically have five years to pay the loan back.  Generally, loan amounts are limited to the lesser of 50% of your account balance or $50,000.  Many employers impose fees and various rules for loans, which can exacerbate your financial problems.  

However, the most probable and most signficant consequence of taking a withdrawal of any kind from your retirement plan is that you set yourself back in terms of funding your secure future.  Retirement plans are there to provide you with a systematic way to save for your “golden years,” the time when you (hopefully) stop working full-time or at a traditional career.  

When you stop contributing or withdraw funds from your retirement plan, you are working against your retirement security.  Of course, many people may ask how else they’ll pay their bills, keep up with their mortgage, or put food on the table without those funds.  If you are in a dire financial situation, you will obviously be looking for any solution – but using your future security to meet your current needs can simply perpetuate your financial problems and create an even greater shortage in the future.

If you are considering using your retirement funds prior to 59 1/2, I highly recommend meeting with a financial advisor who is familiar with budgeting and credit issues.  You may not be familiar with all of the options available to you to help you out of your current pinch such as debt consolidation or negotiating new terms or extensions with your creditors (including your mortgage lender), or you may need help rearranging your expenditures.  An advisor may have constructive solutions or can put you on a set program to help you weather this economic period.  Before taking a hardship withdrawal or loan, consider all options.  It may seem like things won’t turn around, but the economy will pick up at some point and you will be able to get back on your feet.  Don’t sabotage your retirement future if there is another way to deal with your current obligations.

Suzanna de Baca is president of Private Capital Solutions Group. Securities offered through Broker Dealer Financial Services Corp. Member FINRA & SIPC. Investment Advisor Representative of Investment Advisors Corp., A Registered Investment Advisor. Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal or investment advice. Although the information has been gathered from sources believed reliable, please note that individual situations can vary, therefore the information should be relied upon when coordinated with individual professional advice.