Friday, October 14, 2011

Don't be Tempted to Borrow from Your 401(k)

Under the current laws governing tax-deferred retirement plans such as a 401(k), withdrawing money has consequences. I have mentioned many of them here over the years, not the least of which is the early withdrawal penalty, the payment of taxes on those tax deferred investments and of course the loss of retirement money. Yet, those penalties haven’t stopped many of the people who have found it difficult to make their monthly budget work.
Of course, I am assuming a monthly budget. Without some anchor in reality, not having a budgetcan lead to rash decisions withut considering the far-reaching impact. Without a monthly budget, you will have no idea what could be cut to maintain some level of financial stability when times get rough. It is also safe to assume that if you do not have some sort of monthly accounting of your finances, you probably don’t have an emergency account. Both of these would have served the households with troubled income streams.
Two Georgia Congressmen think that those 401(k) plans might be able to help. Their idea: Hardship Outlays to protect Mortgagee Equity (HOME) Act. Introduced last week, U.S. Senator Johnny Isakson (R-Georgia) and U.S. Representative Tom Graves (R-Georgia) want their proposal considered as a way to keep homeowners in their homes. The concept, somewhat like throwing you a lifeline of your own making and designed to rescue you from poverty in the future offers a short-term fix in the near-term. They believe that if you have been a diligent saver, adding to your 401(k) religiously over the years, you shouldn’t be punished for needing the money now as opposed to later.
Rep. Graves is convinced that the housing crisis is the reason the economy has not recovered. Calling up his decades in the real estate business, he suggests: “This bill will help Americans who risk foreclosure use their own resources to make their mortgage payment on time without being penalized by the federal government.” If his assessment of who may need this money now – 23% of those who have mortgages are underwater but not necessarily facing foreclosure – the government should step out of the way and allow these folks to withdraw that money without penalty.
They are proposing that there be a lifetime cap on these withdrawals of $50,000 or one-half of the present value of one’s 401(k) account (whichever is smaller), so long as those funds are used for that purpose within 120 days of withdrawal. This is not the first bill of its kind.
Since the Great Recession began, Congress has struggled with what to do with corner of the financial world. A similar bill was introduced in 2009 and never debated on the Senate floor.
Numerous homeowners should not be in the homes they own in the first place. They may have obtained these residences with fraudulent applications, been unable to afford those homes during what would be considered a normal buying environment and failed to restructure their loans or worse, keep with the terms of their bankruptcy decisions. Because tax-deferred retirement accounts are not considered in these proceedings, some mortgage holders may have been in a position to financially right their own ship. But because of the penalties associated with tapping those accounts, they simply chose not to.
The HOME Act will allow wealthier homeowners to save their residences without penalty, while the rest of us, those that underfunded their retirement accounts or couldn’t wait for Congress to act, have already drained those accounts, paid the penalties and taxes and tried to move on. This effort woud do little to help those currently in the foreclosure vortex or who have been spat out by the continued downturn in housing.
No matter who you are, this last ditch effort is not the way to go. Reducing future retirement payouts (compounding and time suggest that $50,000 in retirement savings would provide only about $290 a month in retirement – a projected shortfall of over $1200) would set the average wage-earner, hardship or no, back decades in support of keeping the house. Few of these folks, given the opportunity and the consequence of this decision will consider the long-range impact of that decision. And if it gets Congressional approval, it will push the real problem further down the road.
On the surface, it might seem like the right thing to do. But beneath the veneer of a tax and penalty holiday the problems this money promises far outweigh the immediate salve it may provide. There are solutions, none of them pleasant.
If you are seeing the problem on the horizon, don’t wait until the day of reckoning. Contact your lender before you run into problems. If the problem has arrived, keep in mind, as devastating as it seems, it is not the end. While temporary may well last several years, longer if you successfully pursue a bankruptcy, protecting your future, a time when this will all be an unhappy bump in life’s road will be worth the sacrifice.
True, protecting your credit is important. Just keep in mind, it wasn’t as important when you bought the house as it is to you now. This too will pass.
The bottom line: those 401(k) provisions were established decades ago when the thinking was to make it painful to withdraw your money all the while giving you the illusion that if need be, you could tap it. Now provision, recent or past will stop you if you have made up your mind. But for those who see this as an exit strategy for a bad decision, this Act will add to the problem.
I know it’s old school but it is worth repeating: get a budget (and figure worse case scenario, not current spending habits to allow a downturn picture to standout), attempt to negotiate before the problem strikes (ironically, most job losses are not a surprise) and divide this time and the future into two separate lifetimes. Borrowing – or in this case, stealing from the future is not a good short-term remedy. It is a bandaid on a gapping wound.
Paul Petillo is the managing editor of and a fellow Boomer.
Paul's latest book "ReBuilding Wealth in a Paycheck to Paycheck World" is available at Smashwords

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