|
In Tough Times, Participants Eye Their 401(k)s
GAS AND FOOD prices are up. Mortgage
defaults are up. It’s no secret we’re entering some
tough economic times. What does this mean for us in the
401(k) industry? Most likely, we’ll start seeing reduced
contributions and increased interest in 401(k) loans and
hardship withdrawals.
Occasional
economic downturns are inevitable, and when they happen,
some participants begin eyeing their 401(k) plans as a
source of additional funding. While these options can
make sense in some situations – ideally as a last resort
- providers have an obligation to ensure that sponsors
and participants fully understand the consequences of
dipping into their 401(k)s.
Let’s look
at the pros and cons of each option.
Reduced
contributions
While this
may seem like the least harmful way to gain a little
extra money each month, it is important that
participants understand how adjusting their
contributions even a little bit can have long-term
impacts on their retirement.
On the one
hand, reducing the monthly contribution can provide
extra money each month without the risks that 401(k)
loans and hardship withdrawals represent.
On the
other hand, the funds no longer going into the 401(k)
are now considered taxable income. As a result,
participants may not receive as much extra money as they
are anticipating.
More
significantly, reducing monthly 401(k) contributions has
the long-term effect of reducing the compounding
interest that is fundamental to 401(k) plans –
especially if the plan includes an employer match. Over
the long-term, reducing the monthly employee
contribution can result in significantly reduced savings
at retirement.
401(k)
loans
Borrowing
against a 401(k) is an option in most plans, and it can
be comforting for participants to know that they have
funds available in times of need. 401(k) loans can
provide fast and simple access to cash with relatively
low interest rates. Their credit is not impacted, there
are no pre-payment penalties and there are typically few
restrictions on what the loan can be used for.
The
downside, of course, is that participants are gambling
with their future for short-term gain. By taking money
out of a 401(k), participants risk altering their
long-term financial plan. Cash for 401(k) loans comes
from the selling of shares in their stock funds. If the
market is down, they may be selling their shares at a
loss, reducing their overall returns down the road.
The biggest
risk, however, is the risk of default.
Defaulting
on a 401(k) loan is the equivalent of a distribution.
Participants who default will pay both regular federal
and state income taxes and a federal tax penalty equal
to 10 percent if under age 59 1/2 on the outstanding
balance.
Hardship
withdrawals
Hardship
withdrawals exist to give a helping hand in the most
extreme situations and should only be used as a last
resort. By design, 401(k)s are designed to keep
retirement money locked away, and participants are
heavily penalized for taking early withdrawals. But
there are exceptions.
In true
hardship situations, participant can gain access to
their funds for needs such as un-reimbursed medical
expenses, the purchase of a principal residence, college
tuition payments and payments necessary to prevent
eviction from or foreclosure on a principal residence.
In most all cases, the IRS imposes a 10 percent early
withdrawal penalty if participants are younger than 59
1/2.
Participants may qualify to take a penalty-free
withdrawal in some situations, such as total disability,
debt for medical expenses that exceed 7.5 percent of
adjusted gross income, court-required payments to
divorced spouses or children or dependents, or
separation from service in the year they turn 55, or
later.
Open
communication is essential
When it
comes to participants in difficult financial situations,
providers and sponsors must tread carefully to ensure
participants fully understand the rules and
ramifications of dipping into their 401(k). This
includes clearly describing what sort of loan provisions
are part of their plan, how borrowing from their 401(k)
may impact future contributions, as well as what does
and does not qualify for hardship withdrawals.
Tough times
are inevitable, but so are eventual rebounds. Take the
time to help participants understand how their actions
today will impact their retirements later.
Jim Daniel is executive vice
president of Corporate Retirement Plan Distribution at
Symetra Financial. He can be reached at
jim.daniel@symetra.com
or 1-800-706-0700.
Headquartered in Bellevue,
Wash., Symetra Financial Corporation provides retirement
plans, employee benefits, life insurance and annuities
through a national network of independent advisors and
agents. For more information, visit
www.symetra.com.
AORP70-0608
|
