Draining the 401k pool of money
A quick search on 401ks in response to reader Noni Mausa: Via Money Central:
Financially stretched workers are increasingly breaking into their retirement accounts to get cash.
Over the past couple of decades, the 401(k) account and its brethren have become the main retirement savings vehicles for millions of Americans. But as the credit crunch and declining home values limit many types of consumer loans, a growing number of workers are tapping into these accounts as if they were piggy banks.
Eighteen percent of workers had loans outstanding from their retirement plans in 2007, up from 11% in 2006, according to a survey by the Transamerica Center for Retirement Studies, a nonprofit corporation funded by Transamerica Life Insurance.
Major retirement plan providers are reporting a similar trend. The number of participants taking loans from their 401(k) plans rose by 7% at the end of last year from six months earlier, according to a JPMorgan Chase analysis of 350 plans nationwide that cover 1.3 million people. Those results followed a period from January 2005 through June 2007 when loans from these 401(k) plans fell by 15%.
Similarly, in 2007, 401(k) plans administered by Fidelity Investments and T. Rowe Price Group posted increases in loans and so-called hardship withdrawals for people who demonstrated immediate financial needs, such as medical expenses, over the prior year.
In all, there was roughly $49 billion of 401(k) loans outstanding at the end of 2006, according to an estimate by the Employee Benefit Research Institute, a nonprofit research group in Washington, D.C.
Trend is ‘alarming’
For workers, a retirement plan loan may seem like a quick and easy solution to a cash crunch. Borrowers don’t need good credit ratings, interest rates are generally relatively low, and interest is paid to the borrowers’ accounts, not to banks.
But the rise in retirement plan loans is “an alarming trend,” says Catherine Collinson, the president of the Transamerica Center for Retirement Studies. “The real secret of building a retirement nest egg is saving over the long term on a consistent basis,” she says. Hitting up your retirement account for cash throws a wrench into this process.
There are other reasons why borrowing from your 401(k) can wreak havoc on your finances. A worker who leaves a job before a loan is paid off will have to pay the remaining balance in full or else face taxes and potential penalties. What’s more, given the stock market’s recent declines, participants now borrowing from plans may be selling assets at depressed values to fund the withdrawals.
Link to foreclosures seen
Why the surge in 401(k) loans? Until recently, soaring home prices made it easy for consumers to tap their home equity for funds. But now that home prices are dropping rapidly in many markets, more workers, loaded with debt and struggling to make mortgage payments, are turning to their retirement plans.
Talk back: What is your retirement target number?
In the Transamerica study, which surveyed more than 2,000 full-time employees at for-profit companies, 49% of those who borrowed from their retirement savings said they had taken the loans to pay off debts, up from 27% in 2006.
In some instances, workers in fear of home foreclosure may be tapping retirement funds as a last-ditch measure, says Anne Lester, a senior portfolio manager at JPMorgan Asset Management.
It is marginally intelligent for the government to subsidize savings. It is stupid for it to subsidize debt. It is REALLY stupid to do both at the same time, unless your goal is to enrich bankers.
Next year, my wife and I will purchase our new home. In a rational world, I would pay cash, thus avoiding any interest. However, we won’t. Why? Because more than half of our savings are in a 401k, which is subsidized and largely untouchable, and because the debt we would accrue would be partially tax deductable due to the mortgage interest deduction. Add them together, and these two subsidies are greater than the savings we would get by avoiding the interest, and hence we borrow rather than pay cash.
But who are the real winners here? Not us…e barely come out ahead. The banks, however, make out like a bandit, as they get to steal 0.3% of our 401k’s each year and charge us 4% on the loan.
The mortgage interest deduction needs to go. As a side issue, IRA’s of all types should be capped at a lifetime max of $3 million (with automatic inflation adjustment) and only be allowed to utilize publically traded securities and funds, lest the owners of the 401k’s stuff their tax-sheltered IRA’s with undervalued corporate fragments of their own creation (ahem, Romney).
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