Nonessential Luxuries Aren’t Worth 401(k) Penalties

 With the price of food and gas on the rise, a 401(k) balance can begin to look pretty tempting as a source for making larger, nonessential expenses or to take a family vacation this summer. More than half of all 401(k) plans offer loan options prior to retirement for the lesser of 50 percent of the vested amount or $50,000. But there’s a reason they call it a “hardship” withdrawal, and that word should factor in to any decision you, your adult child or another family member makes to tap retirement savings for anything other than retirement. 

A February Financial Advisor magazine article reported loans taken against 401(k) savings are less than their 22 percent peak in 2010, but many firms still estimate between 13 to 18 percent of retirement accounts have a 401(k) loan. More than 25 percent of the $294 billion deposited into 401(k) funds annually is being used for non-retirement purposes including mortgage payments, credit cards or other bills. Time magazine reported penalized withdrawals from 401(k) plans increased to more than $60 billion in 2010, up from $36 billion in 2004. 

The temptation in using a 401(k) loan is similar to that of a home equity loan – the old “I can just pay it back later” rationale. Consider the implications, however, of not being able to pay the loan back because of disability or loss of your job. Consider the loss of future investment gains and compounding opportunities by taking that money out of play now. Consider you will be borrowing pre-tax dollars and repaying the loan with after-tax dollars, so you will have to work more hours to replace the same amount of money. And consider the fees that your plan may impose on loans, such as asset liquidation fees. 

Vacations, new cars, going back to school for a second (or third) degree and even buying a home are not hardships. These are expenditure decisions that should be worked into your budget – not borrowed from your future. If you or a family member is considering a 401(k) early withdrawal, hardship withdrawal or loan, you may want to consider contacting a Certified Financial Planner for help in considering all the implications. 

FINANCIAL FACTS

Not Now, But When? – Forty-six percent of American workers age 20-29 that have access to a pre-tax 401(k) retirement plan do not participate in the plan (source: Aon Hewitt, BTN Research).  

More Going In Than Coming Out – An average high income American couple that retired in 2010 will pay $765,000 of lifetime Social Security taxes but receive just $693,000 of Social Security benefits, i.e., for every $1 paid in taxes, the couple will receive $0.91 in benefits (source: Urban Institute, BTN Research).  

We’re Spending A Lot – Total retail sales in the U.S. in calendar year 2012 were $4.88 trillion, up 5 percent from its total in 2011.That’s equal to $234 billion of additional retail sales in 2012 (over 2011’s result), or $1 million of additional retail sales nationwide every 2.25 minutes (source: Census Bureau, BTN Research).