Interesting article Monday in InvestmentNews regarding a decline in 401(k) loan applications and what that means:
Apparently, they are trying to put a good spin on the decrease. The fear has been that as the economic ‘dominoes” fell, that 401(k) balances would be the next place attacked by desperate Americans. The thinking was, as interest rates rose on resets, and as layoffs increased a bit, people would turn to equity lines and credit cards to make up shortfalls. Then as lenders shut off equity lines and people maxed out credit cards, they would go through their savings. Seeing as we don’t save much, economists closely watched 401(k) loan activity to see if people would take out loans to make up the shortfall.
The reason 401(k) loan activity is closely watched is that once you have borrowed 1/2 of your balance, you can’t take anymore. The only recourse is a “hardship withdrawal” and only if your plan permits it. And then, once 401(k) money is gone, then the consumer would be 100% drained and bankruptcies would follow en masse (hence this is important economic news to know!). Amusingly, people interviewed in the article take a bit of comfort in the fact that 401(k) loan applications dropped 7% this year from last year. of course we haven’t come to the all important holiday season when people really spend money and when utility bills skyrocket in the Northeast.
Anyway, yes they mention in the article that 401(k) loans are down but that hardship withdrawals are up; however, they (401(k) company representatives) say “that in those cases, most people desperately need the money to prevent home foreclosures.” Oh OK, the way they word that it sounds like there’s no problem. If it’s only to prevent home foreclosures, then lets not even worry about those pesky hardship withdrawals – let’s just be thankful that loan applications to 401(k) companies are down 7% year over year.
C’mon are you serious? Hardship withdrawals often do not avoid the 10% early withdrawal PENALTY or the TAXES – taking this step is MUCH more serious than taking a 401(k) loan. And if you read further down in that article, you see that hardship withdrawals are UP 22.7% across all of Merrill Lynch’s sponsored 401(k) plans. WOW.
Think for a second – perhaps loans are down because fewer people are using these loans to BUY A HOUSE and more just to PAY OFF BILLS. I take this hardship withdrawal news as very serious. In the article, someone mentions 401(k) loans as a last resort for troubled consumers. I would disagree – I think hardship withdrawals are the last resort because taxes and penalties may be due on a hardship withdrawal but not on a 401(k) loan.
Let’s keep an eye on this development as we head in the Fall and Winter.
For a more recent article on this topic: 5 Things to Consider Before Taking a 401(k) Hardship Withdrawal
P.S. Many people continue to read this article week after week since I first published this on September 2, 2008. I know many people are struggling with this because money is tight and quite a few Americans have lost jobs and are experiencing tight cash flow. Remember, if you need to tap a 401(k), there may be smart ways to do it and there are definitely dumb ways to do it. Be careful!
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