More People Dipping into Retirement Accounts to Prevent Foreclosure
American families struggling against eviction and foreclosure have found a new source of income to help them stay in their homes, according to USA Today. But the long-term effects could be disastrous.
Reports indicate that more and more Americans are taking "hardship withdrawals" from their 401(k) plans explicitly to prevent foreclosure or eviction, sometimes at enormous cost. A CBS News affiliate reports that hardship withdrawals from 401(k) plans can come at a hefty price.
What is a hardship withdrawal?
Unlike loans, hardship withdrawals from 401(k) plans don't have to be paid back. They're designed to help those who need money but cannot get funding from another reasonable source, reports indicate. Specifically, those who are buying a first home, paying certain education costs, paying for a funeral, covering serious medical expenses, making home repairs or preventing eviction or foreclosure are entitled to hardship withdrawals.
The current foreclosure crisis has practically forced people to drain their retirement accounts, since so many other sources of credit are drying up.
The costs of hardship withdrawals
Unfortunately, taking money out of your 401(k) plan before a certain point can prove costly. Apparently, if you're younger than 59 and a half, any money removed as a hardship withdrawal is taxed like regular income, plus reduced by 10% as a penalty.
The vast majority of plans that permit hardship withdrawals evidently do not allow employees to contribute any money to their 401(k) plans for at least six months; further, the money cannot ever be repaid. And sources note that employees are required to provide a reason in writing for their financial need.
This means, of course, that employers learn all about the troubles at home.
Foreclosure Prevention?
According to sources, several businesses have noticed significant increases in hardship withdrawals for those looking to stop foreclosure or eviction. USA Today notes that Merrill Lynch recorded a 23% increase in January '08 from a year ago, Great West Retirement Services has seen a 20% increase and Principal Financial has had five and a half times more calls about hardship withdrawals than this time last year.
And often, people dipping into their retirement accounts find themselves in an unfortunate predicament: though many plans allow 401(k) loans, which are not taxable and can be paid back, those trying to stave off foreclosure don't need another bill to pay each month.
But the fact remains that money in 401(k) plans is meant for retirement, and too many families, it seems, are facing the unpleasant choice of losing their homes now or losing their plans for retirement later.