More Consumers Cashing in their 401K

Consumers may be maintaining the highest 401k balances in over 12 years, according to Fidelity Investments, but they’re also borrowing from these retirement savings at a much more frequent rate.

The firm found that employee 401k contributions have increased by 7 percent over the past five years, and the average account balance is now more than $75,000. But what the Employee Benefit Research Institute (EBRI) recently published is painting the employee-401k relationship in another light.

401K Borrowing at Highest Rate Since 1996

Up against staggeringly high unemployment and more restrictive lending terms, workers are borrowing against their retirement savings at an increasing rate, creating an uncertain future for their post-work financial status.

“When cash is tight people are looking anywhere they can,” said Paul Lemon, president of Integrated Financial Planning. “Banks aren’t lending money to people, so they have to take it from retirement.”

According to a recent EBRI study, 21 percent of people borrowed from their 401k in 2010, the highest rate in nearly 14 years, and almost 4 percent higher than before the recession.

The report found that the average loan amount is 14 percent of remaining account balance.

Although 401k loans are less common than personal loans, an Aon Hewitt study found that 40 percent of employees cash out their 401ks when they leave a job, rather than transferring them to another retirement plan. They found this to be most frequent among their 20-something workers.

Cons Often Outweigh Pros of a 401K Loan

Borrowing against your 401k savings may come with certain benefits. You don’t have to undergo a credit check to qualify and you don’t have to provide a reason as to why you’re borrowing the money, but these short term benefits are met with long term repercussions.

Tax Hit, Times Two: When employees borrow against their 401k, the loan repayments are made with after-tax dollars. So you end up paying the loan off with your income, which has already been taxed, by replenishing your non-taxed account with taxed money, thus reducing your cash flow to repay the loan.

Career Change? Think Twice: If you’re amid a job search, definitely consider other options rather than borrowing from your 401k. Repaying the loan can become an issue if you leave your employer before you pay off the loan.

If this happens, the balance is due in full, typically within 60-90 days, and failure to pay means you’ll now owe the full amount in income taxes. Also, if you’re under 59 ½, you’ll also have to pay a 10 percent tax penalty.

Making Up for Lost Contributions: Depending on the entire amount you’ll need to borrow, the cost to repay your 401k loan can become tough to manage in addition to your regular monthly contributions.

“The guidance we try to give people is make sure they know when their money is out of the 401(k) it’s not working for them,” said Mike Shamrell, of Fidelity, “especially in the last year when we have seen positive market behavior.”

The bottom line for consumers is that even though you may be tempted to borrow against your retirement savings, the short-term assistance can also be detrimental to your future. You’re borrowing from yourself, but the money comes with the price of borrower-lender transaction with interest payments and tax penalties.

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