retirement

Last resort: Raid 401(k) to beat foreclosure

You've heard the news: Foreclosures are up, home prices are down and even borrowers with good credit are increasingly late with their mortgage payments.

Previously, many of those borrowers would look to home equity as a resource to cover shortfalls. But with that option off the table for many, increasing numbers of people are considering tapping into a second large asset -- retirement savings.

For some people, "It's more important to have the cash in hand today than in retirement, which is a much more abstract goal," says Brad Huffman, a Certified Financial Planner with Future Finances in Columbus, Ohio.

Most 401(k) plans and IRA accounts have rules in place that let you use your retirement savings to prevent foreclosure on your primary residence, either by offering loans on the balance or allowing you to simply withdraw the money.

"Congress wrote the rules so that in an emergency you can use the money to meet your needs," says Stephen Utkus, director of Vanguard's Center for Retirement Research. "The rules reflect a realism about our financial lives."

About 85 percent of employees with a 401(k) have access to loans, and 89 percent of 401(k) plans will let you withdraw money if times get really tough, according to 401khelpcenter.com. A closer look shows 18 percent of workers had a loan outstanding from their retirement plan last year, according to the Transamerica Center for Retirement Studies. And the Employee Benefit Research Institute says approximately $320 billion in 401(k) loans were outstanding at the close of 2006.

But is tapping hard-earned dollars earmarked for your golden years a good idea?

Before you use retirement assets to bail yourself out of a housing crisis, there's a lot to consider. It might not be the life raft you'd hoped it would be, and you could be making an irreparable dent in your retirement assets.

Option No. 1 -- Borrow
If you participate in an employer-sponsored 401(k) plan, you likely have two options to get needed cash. You can either take a loan against your account balance or take a hardship withdrawal.
“There are no penalties or taxes on 401(k) loans, but you'll miss out on market gains on the amount you've borrowed.”

The loan is the easiest to get. The rules vary from employer to employer, but in general you're eligible for a loan of up to $50,000 or half of your vested 401(k) balance, whichever is less. The money must be paid back within five years, with interest. Payments start immediately, and usually are deducted from your paycheck. One important thing to keep in mind: Loans must be paid back with after-tax dollars, which could put a big dent in your ability to contribute pre-tax dollars to your 401(k).

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There are no penalties or taxes on 401(k) loans, but of course you miss out on market gains on the amount you've borrowed.

If you quit or lose your job before the loan is paid off, you have 90 days to pay the remaining balance. If you don't, you'll get socked with a 10 percent early withdrawal penalty if you are younger than 59½, and you'll have to pay income tax on the money you took out of the plan.

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