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Wednesday, January 16, 2013 12:06 AM

Over 25% of 401Ks Tapped to Pay Current Bills; Dead-Fish Housing Assets; Walking Away Yet Again

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At an increasing rate, even during the alleged recovery, consumers are tapping their 401Ks to pay current bills according to a study by advisory firm HelloWallet as describe in the Washington Post article 401(k) breaches undermining retirement security for millions.

A report due out this week from the financial advisory firm HelloWallet found that more than one in four workers dip into retirement funds to pay their mortgages, credit card debt or other bills. Those in their 40s have been the most likely culprits — one-third are turning to such accounts for relief.

The withdrawals, cash-outs and loans drain nearly a quarter of the $293 billion that workers and employers deposit into the accounts each year, undermining already shaky retirement security for millions of Americans.

Fresh data from Vanguard, one of the nation’s largest 401(k) managers, show a 12 percent increase in the number of workers who took loans against their retirement accounts or withdrew money outright since 2008.

In 2010, 28 percent of participants reported having an outstanding loan against their retirement accounts, an all-time high, according to a survey of 110 large employers by Aon Hewitt, a human resources consultancy. And nearly 7 percent of employees took hardship withdrawals that year — roughly a 40 percent increase since the recession, while 42 percent of workers cashed out their plans rather than rolling them over when they changed jobs.

“401(k)s are not being used for retirement by a large and growing share of workers because they are misaligned with the very basic financial problems most workers face and must address,” said Fellowes of HelloWallet, which provides benefits advice to companies.

Using data from the Federal Reserve’s Survey of Consumer Finances and the Survey of Income and Program Participation, conducted by the Census Bureau, the report said 30 percent of households earning less than $50,000 a year had cashed out a retirement plan for non-retirement purposes. Only 12 percent of households earning between $100,000 and $150,000 a year and 8 percent of those earning more than $150,000 a year have cashed out a retirement account, the report said.

“The investment advice out there needs to recognize that a large share of participants is not going to use the money for retirement, so they should not be exposed to risky investments,” Fellowes said. “There is no investment adviser in the country who would put workers in the stock market if they were told the money being invested was for short-term needs.”
Mortgage Connection?

The Washington Post article failed to note "why" people were tapping their 401Ks.

I suspect, but cannot prove, that many low-income households are desperately clinging to their underwater houses, from which they would be better advised to seek council, then walk away.

Higher income groups seem to have less aversion to walking away than those who struggled all their lives to get a home, only to get one at exactly the wrong time.

Dead-Fish Assets 

The mentality "My house is the only thing I have" is tough to fight. However, the reality is many homes are worth less than zero because of underwater situations.

Unfortunately, the financial industry is geared to giving the worst advice to the least well off. Counseling groups (typically bank-sponsored) encourage people to keep their dead-fish "assets", best flushed down the toilet.

There are other possible reasons of course, and right at the top of the list is car loans, another depreciating asset.

Lose Your Job, Then You're in Trouble

I do not advise tapping your 401K for numerous reasons, but right at the top of the list is the lost-job nightmare.

Please consider these problems as excerpted from the 401K Calculator article Everything You Need To Know About Borrowing Against Your 401K.

  1. If you lose your job or if you decide to leave your employer, you will be required to pay off the loan in a lump sum. If you don’t, you face the potential of the loan defaulting, which will result in a taxable event.
  2. As you pass-up the tax-free compounding of the money you withdraw, you could end up with a significantly smaller fund on your retirement.
  3. Interest payments from a 401(k) loan are not tax deductible. 
  4. You will also pay taxes twice on the amount you took out for a loan.  Your 401k loan payments are deducted after taxes have been taken out of your paycheck. However, since pre-tax money is usually used to fund a loan, the payments are put back into your 401(k) as pre-tax funds. This means that when you take the money out later, you will have to pay taxes on it again.
  5. There is no flexibility with the terms of repayment and your loan repayment is done automatically through payroll deductions, which will reduce your take-home pay.

Recommended Options

401K Calculator writes "Before you take out a 401k loan, it’s vital that you explore other options. Using savings or other types of loan may be a more suitable alternative to borrowing against your retirement funds. You should be careful not to jeopardize your retirement just for a quick cash fix now."

I concur, while adding ... If the reason for the loan is to make a mortgage payment on an underwater home, or if you are for any reason close to bankruptcy, please consult a bankruptcy/mortgage attorney in your state for other options.

"Walking Away" and/or bankruptcy may be far better options than tapping 401Ks.

Unfortunately, I highly suspect many have trashed their 401K to keep or buy rotten fish. Most of the rest are likely bankrupt and on borrowed time, wasting their 401K in a futile attempt to prove otherwise.

Mike "Mish" Shedlock

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