retirement

401(k) hardship withdrawals on the rise

Loans depend on company

Loans from 401(k)s are allowed under IRS rules, but not all company plans permit them. Generally, an employee may borrow up to half of the vested balance to a maximum of $50,000. The loan must be repaid within five years unless the money is used to buy a home. The loan isn't taxed, but you repay it with interest which is credited to your account. If you leave the company, you must repay the loan right away or it's considered a withdrawal and is taxed and penalized.

"Congress did not prohibit hardship withdrawals, did not prohibit loans and did not prohibit you touching your money when you change jobs," notes Vanguard's Utkus. "The tax policy in the U.S. is designed to create disincentives but never prohibitions.

"There's a good argument to be made for absolute prohibitions because you want to protect retirement savings, but I think economists persuaded Congress that sometimes there are worse things than not saving for retirement and those include losing your house, unemployment, huge medical expenses and financial catastrophe. Sometimes if the only asset you have is your 401(k) savings, it's economically sensible to use it for other purposes."

Think before you tap

Before you tap your 401(k), take time to see if there are alternatives. Your retirement plan should be the last resource you consider.

Steve Juetten, Certified Financial Planner and principal at Juetten Personal Financial Planning in Bellevue, Wash., has several steps that he advises people to take before tapping a retirement plan during a financial crisis:

Review the last 6 months of expenses and classify them into needs and wants. "Most people spend about 80 percent of their income on seven or eight main categories, such as food, clothing, shelter, gas, insurance and the like. There isn't a lot of variability in that. It's the other 20 percent we're going after. After you've separated the needs from the wants, stick to a plan that spends only on the things you need, not the things you want."

Stop 401(k) contributions. "If you have to stop, then stop. Just make the commitment that you will go back to it at a point and stick with it. This is a very short-term approach. Let's take care of the emergency we have right now. Let's do what we have to do to keep body and soul together, but we need to get back to savings when this crisis is over."

Involve the family. "The kids need to be involved, both parents need to be involved, whoever your family is -- let them know what's going on, what you're doing and how everyone can contribute. Pennies add up to dollars and dollars add up to many dollars. Everybody can help."

Make minimum payments on credit cards. "If you have credit card debt and you stop paying, it will affect your credit rating. Make the minimum payments and make them on time."

Take a loan rather than a hardship withdrawal if you can. "Everybody's situation is different, and if you're really strapped, you may need to take the hardship withdrawal because you start repaying a 401(k) loan immediately and it comes out of the paycheck. Don't take a bigger loan than you need just to cover the initial payments. If you're going to take a loan, stop making contributions. But a hardship withdrawal is taxed and there's a penalty, and you need to take that into account."

Even people who are getting through the current crisis relatively unscathed should make sure their emergency funds are adequate. Employees may not be fully aware of how much cost increases are impacting their companies, and a job loss can happen whether or not you expect it.

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