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Loans > Personal Loans
Workers should avoid borrowing from 401(k) savings accounts
EILEEN ALT POWELL, AP Business Writer. Associated Press
Copyright Associated Press
NEW YORK (AP) _ For some people in need of quick cash, a 401(k) retirement account can look pretty tempting. It's often their biggest pot of savings, and most company plans are set up so participants can borrow from them in emergencies.
Experts caution, however, that tapping these accounts carries risks, not only in reducing the total savings available for retirement but also in triggering taxes and penalties if the loan isn't paid back.
"Borrowing from a 401(k) or other retirement savings account is a terrible thing to do," said Dallas L. Salisbury, head of the Employee Benefit Research Institute in Washington. "It should be a last resort _ if you really, really need to borrow money and that's the only place you can do it."
Still, surveys by the nonprofit group indicate that about one- fifth of participants in plans that allow borrowing do take out loans. The limit is 50 percent of the account's balance, or $50,000, whichever is lower. The average outstanding loan is about $6,800, the surveys show.
People do, of course, face emergencies that require quick access to cash.
They often look to their 401(k) accounts, or the 403(b) accounts for workers in nonprofit industries, because it's easier to tap them than it is to take out a personal loan or qualify for a home-equity loan. Anyway, the argument goes, you're essentially borrowing from yourself and repaying the money with interest, generally a point or two above the prime lending rate.
But that ignores the long-term costs.
Nationwide Financial, a Columbus, Ohio, company that administers retirement plans, provides these calculations: A 35-year-old worker who usually makes $2,000 a year in contributions to his 401(k) plan takes out a $10,000 loan. If, over the five-year repayment period, he discontinues his annual contributions, he will have $134,950 less at age 65 than if he had continued his regular savings. Even if he continues his contributions during the repayment period, his account will be reduced by more than $9,000.
Judy Miller, a financial planner who heads the College Solutions advisory service in Alameda, Calif., says that would-be borrowers "shouldn't forget that they forgo what they would have earned on that money had it been invested," most likely at a higher rate than the loan is pegged at.
In addition, "you're essentially a prisoner of your employer" because the loan is due in full if you leave your job or lose your job, she said. If you can't repay the balance, the IRS considers it a "distribution" that is subject to federal taxes, a 10 percent penalty and state taxes. That can equal more than 50 percent of the loan principal.
And where do borrowers get that kind of money? Raiding what's left of the 401(k), leaving them with substantially reduced retirement savings.
"The reality is that just as you layer your clothes to go from warm to cool temperatures, you need to layer your savings," Miller said.
That means setting up an "emergency" account with three to six months of living expenses, a separate college savings account and retirement accounts.
David Wray, president of the Profit Sharing/401(k) Council of America, a Chicago-based trade association that represents retirement plan sponsors and members, says that the borrowing provision in retirement plans is critical to attracting savers.
"A government study as well as private studies have found that employees want to know that in an emergency, they have access to their money," Wray said.
That's especially true for low- and moderate-income workers, he added, "because in many cases, the 401(k) is the only savings plan they have." Their most frequent emergency, he said, was repairing a car that broke down or replacing one that stopped running _ a necessity for many to keep their jobs.
He also points out that borrowing is not taking a huge bite out of the nation's retirement savings pot: Just 2 percent of plan assets are out as loans.
HFC Personal Loans
On the Net: www.ebri.org www.nationwide.com www.4collegesolutions.com www.psca.org
End advance for use anytime.
Reproduced with permission of the copyright owner. Further reproduction or distribution is prohibited without permission.
Dateline: NEW YORK
Text Word Count 666
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