Tapping the Retirement Kitty

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By Martha M. Hamilton
Sunday, January 27, 2008

Thinking of dipping into your retirement savings to get through hard times? It's a tempting prospect -- and it could become even more tempting as signs increasingly point toward economic troubles on the horizon.

But before you tap that ready pot of cash, you may want to think again. There are significant downsides to drawing early from your accounts.

Even so, there is evidence that people are doing it in growing numbers.

According to Fidelity Investments, one of the nation's largest managers of retirement plans, investors are turning more frequently to their savings to pay for current needs.

"We have seen a dramatic increase in the number of hardship withdrawals -- up 17 percent year over year," said Jamie Cornell, Fidelity's senior vice president of marketing.

Hardship withdrawals, which often require fees and tax payments, are just one way of tapping retirement funds. Cornell said investors also have more loans outstanding against retirement savings plans -- and the amounts of the loans are getting larger. People age 59 1/2 and older, who are permitted to take money out without penalties, are withdrawing from their accounts in "the highest numbers we have ever seen," Cornell said.

Sometimes it may be impossible to surmount financial difficulties without draining money from your retirement plan. But spending the money now could mean you have less in retirement, when you may need it even more.

The law allows hardship withdrawals on the theory that, without them, it would be even harder to get workers to participate in savings plans. Some companies, however, may not offer withdrawals or loans as part of their plans. Before embarking on a hardship withdrawal, you should carefully consider the restrictions and costs. Withdrawals are permitted for the purchase of a new home, medical bills, higher education, funeral expenses, or to prevent an eviction or other severe financial distress. They require extensive documentation for the Internal Revenue Service, and you must have exhausted all other options. You don't have to repay the money to your 401(k), but you do pay a 10 percent penalty unless you fall into certain categories, such as being completely disabled. You're also likely to have to pay taxes on the money withdrawn.

The move really is a last-ditch alternative.

Borrowing against your 401(k) may make sense in some situations. If your mortgage payments go up (as will be the case for many borrowers with adjustable rates in the next few years), and you can buy some time to help come up with a sustainable financial situation, you might want to consider it, said Stephen P. Utkus director of the Vanguard Center for Retirement Research. "You have to look at the risks and the benefits. It's not risk free." For example, if you lose your job or change jobs, you have to repay the loan in full.

However, there are some advantages, he said. For example, there is no underwriting -- that is, no lender combing through your assets and liabilities and checking your credit score. Also, you will be paying yourself interest instead of paying interest to someone else, and the interest rate may be lower. (The flip side is you might be able to earn more on your investments than you are paying yourself in interest.) You may borrow up to $50,000 or 15 percent of the account balance, whichever is higher.

"Suppose you think in the next year you can refinance the house. Or you're selling the house and getting something cheaper. Or another family member is going to start work and will have some money in six months," said Utkus. Or you may be getting to the end of some other expenses, say, for school or your car payments. "What you have to think about is: Does it buy you some time to fix the underlying problem?"


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© 2008 The Washington Post Company

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