401(k) retirement savings accounts are used by millions of Americans to save for their future. During the collapse of stock market in late 2008, 401(k) plans were hit hard. While the stock market has recovered since then, the economy is still in bad shape with a slow and anemic recovery.
Almost 14 million Americans are still unemployed and a lot of households are finding it difficult to make ends meet if one of the earning members is unemployed. With long-term unemployment hitting record levels, a lot of people are tapping into their 401(k) accounts for financial emergencies.
Slow economic recovery
Consumers feel that if other financial resources can’t be tapped for a personal loan then it is best to depend on their 401(k) accounts. According to a latest report release by human resources consulting group Aon Hewitt, one out of seven people looked at 401(k) accounts for loans. In 2010, there was a 19% increase in loans, while hardship withdrawals increased by 7%, and 30% of all plans had an outstanding loan. This could be directly attributed to the poor economy and tightening of credit options.
How it works
If an employee actively contributes to his retirement plan, he can draw either up to a maximum of 50% of the balance or $50,000. These loans must be repaid in five years at the market rate from employee’s salary. While the employer fixes the terms of the loan, the employee returns the interest to his account. However, each state has its own rules, so state guidelines must be checked.
One way of withdrawing money from one’s retirement savings prematurely is to take a hardship loan, though it attracts stricter penalties and eligibility criteria. If an employee takes this loan for a housing or medical emergency, it is taxable. For the next six months after taking the loan, he cannot contribute to his 401(k) plan.
Eligibility criteria
If an employee holds down a good job, he/she can take out a loan in these situations:
- For a bigger down payment for a house, which will enable them to get a home loan with tax benefits.
- When his retirement savings are ahead of schedule.
- When an employee over-funds a plan for money to be available for his child’s future education.
An option, but not the best option
If an employee borrows against his retirement plan, he loses the benefit of compounded savings. People who borrow from their retirement plans don’t usually restore the loan amount to their savings.
Besides, by taking a loan, it is assumed that the employee will continue in the same job until he fully repays the loan. If he quits his job or loses it midway, the balance of the loan must be repaid within 30- 90 days. The amount to be paid after this period is taxable, and any default on payments attracts a 10% penalty.
About the author: Article courtesy of Credit Season, a consumer finance website providing news, information and tools for personal loans and other personal credit services.
Credits: Photo courtesy of Nelson Kwok.