Ideally, one never starts withdrawing from their 401(k) fund until they hit the eligible age as doing so is kind of counterproductive. However, a number of people take 401(k) loans every year, many by lower-income workers, a number of whom never pay it back and get in deeper trouble.
Study finds many use 401(k) loans as crutch in lieu of savings
Taking money out of one’s 401(k) is generally not a good idea. Granted, in some scenarios, it isn’t the worst idea; as Forbes points out, if used for short term loans and the end result is that costs are lower than using credit cards or other credit sources, it works.
However, that’s under ideal circumstances and when does anything, anywhere, ever occur under ideal circumstances?
A recent survey, according to Reuters, by Hello Wallet, found that those making around $50,000, or the national median income, are at the highest risk of taking 401(k) loans. Of workers making that income level or less in the Hello Wallet survey, 30 percent had borrowed from their retirement accounts. Of workers making between $100,000 and $150,000, 18 percent had done so and those making $150,000 or more, only 8 percent had.
Taking 401(k) loans isn’t like borrowing a loan in the traditional sense, in that interest isn’t expressed in the traditional manner and one is technically borrowing from one’s self, rather than from a lender. However, there are penalties for not paying it back.
Borrowers have 60 days to repay the loan, or else they face a 10 percent early withdrawal penalty, according to ABC. They also have to pay a 10 percent surcharge to make up the accrual and interest that money would have gained had it remained in the 401(k) account.
Unfortunately, a lot of borrowers wind up in default. Estimates vary and many aren’t rosy. For instance, a study by Robert Litan of the Brookings Institution and Hal Singer of Navigant Economics estimated $37 billion in 401(k) loan defaults would occur in 2012, up from $665 million in 2007.
Number of solutions offered
It would appear that most use 401(k) loans as help in a clutch. Aon Hewitt, a benefits administration company that handles 401(k) plans among other things for a large number of companies, found most 401(k) borrowers were between 40 and 49 years old, a demographic highly likely to have children and be keeping up with the Jones’. In other words, people old enough to have something to lose.
Some believe making the option available could help cut down on borrowing. Of participants in Litan and Singer’s study, 95 percent reported they were able to borrow from their 401(k). Aon Hewitt suggested that since the majority of plans, 58 percent, allowed more than one loan, it could be making the option too easily accessed. An application fee might also ward off potential borrowers to look to more conventional options.