Most 401(k) plans allow participants to borrow up to half of their account balance (but not more than $50,000) and repay the loan over five years. But that can take a big bite out of your future savings because any money you withdraw loses the power of compounding.
In addition, if you change or lose your job, the loan is due immediately. Fail to repay it and the money will be treated as a distribution that is subject to state and federal income taxes, plus a 10% early-withdrawal penalty if you are younger than 55. Some plans offer hardship withdrawals that do not have to be repaid, but they're still subject to taxes and a penalty that can wipe out up to half of your distribution.
You can't borrow from a traditional IRA, but you can withdraw your money at any time. However, you'll pay taxes on the withdrawal and, if you are younger than 59, a 10% penalty, too. If you have a Roth IRA, you can withdraw your contributions (but not the earnings) at any time tax-free and penalty-free.
Gregory Dyson, senior vice-president of marketing for ICMA-RC, which provides retirement-related services to state and local government employees, gives this example of the long-term impact of premature withdrawals.
Let's say you are 35 years old and have a retirement-account balance of $30,000. If you take a $15,000 hardship distribution, it would cost you more than $122,000 in lost savings over the next 30 years, assuming an average annual investment return of 7%. "That's a very high price to pay for a short-term fix," says Dyson.
If you're really squeezed for cash and feel you have no choice but to cut back on your savings, at least try to contribute enough to capture your employer's match. Otherwise, you're walking away from free money.
A recent evaluation of nearly one million 401(k) participants by Financial Engines, a leading provider of investment advice and managed accounts, shows that one-third of workers failed to contribute enough to capture the full company match. With depressed stock values, you'll have the added advantage of being able to buy more shares at lower prices.
Reprinted with permission. All Contents © 2008 The Kiplinger Washington Editors
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