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Dipping into retirement is risky business

April 16, 2008 12:00:00 AM PDT
Due to tough economic times more people are raiding their retirement savings to borrow money, or pay down debt. Taking money from a 401(k) or retirement account may seem like a good idea to pay off debt.

And under certain circumstances it might make sense, but beware of making a hardship withdrawal.

Twenty-six-year old Chris Fickey is getting a jump-start on saving for his golden years. He signed up for his company's 401(k) plan right after college.

"I do hope to save up enough so I can retire when I'm in my mid-60s," said Fickey.

Like most of us, Chris plans to leave his 401(k) money alone until retirement. But today, a growing number of consumers are in such dire straits, they're literally cashing out part of their 401(k) plans early through something called a hardship withdrawal.

"With the increased unemployment rate, the downturn in home value and home equities, I'm pretty sure that that's driving a lot of those increases," said Rick Meigs, 401k Help Center.

By law, you can only qualify under certain financial hardships such as, un-reimbursed medical expenses, college tuition or potential eviction or foreclosure.

"The IRS and Congress don't want people depleting their retirement accounts for frivolous reasons," explains Meigs.

If you're of pre-retirement age and in the 25 percent tax bracket and need to withdraw $20,000, you'll be hit with $5,000 in federal income taxes. Plus you'll likely face an additional $2,000 in penalties for taking the money out early. You're only able to keep $13,000.

"A loan faces no taxation and no penalties," says Meigs.

If you're not facing foreclosure, experts suggest homeowners consider refinancing since interest rates are down again, a home equity loan is another possibility.

"We'd recommend meeting with your financial advisor and looking at all your liabilities, looking at all your assets, shaking every tree possible, seeing if there's anything you can get before you do the hardship," says Mary Jo Harper, Merrill Lynch, Financial Advisor.

An important note: not all plans allow hardship withdrawals. So check with your administrator if you're in need. Typically, if you withdraw money from your 401(k), you cannot make new contributions to the plan for six months.

 

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