Friday, September 24, 2010

Your Questions about 401(k) Loans & Withdrawals

On ABC News Now and KLOVE this past week, I answered YOUR questions!



Q. It seems like every other friend of mine is taking the loan option on their 401(k). How many people are doing this?

Samantha Jones from Pennsylvania
Submitted via twitter

ELLIE: The second quarter report we talked about earlier also noted an increase in 401(k) loans. If you want to go the loan route, you need to know that workers are required to exhaust all other sources of fund—including a 401(k) loan—before they can take a hardship withdrawal. During the past 12 months 11% of plan participants initiated a loan, which is up from 9% during the previous 12 month period. 22% of plan participants had outstanding loans during the second quarter vs 20% a year earlier.

Q. If you want to take a loan on your 401(k) what kind of a reason do you have to give?
James from Fort Worth, TX
Submitted via facebook
ELLIE: A loan option is not a hardship option. For a hardship, you have to have specific reasons that fall within a certain criteria established by the IRS and/or the company. But for a loan, you don’t have to give a reason. You can take up to $50,000 or 50% of the amount in your plan, as long as it is vested by company rules, whichever of these is less. Since you are required to take a loan before you can apply for a hardship, this means that you will have little to nothing left in that account by the time you are done raiding your 401(k).

Q. If you take a loan against your 401(k), then what kind of a percentage point do you have to pay when you pay it back?

ELLIE: Most plans charge 1 to 2 percent above prime, which means currently 401(k) loan rates are as low as 4.25%. Loan payments are deducted from your paycheck. You can still contribute to your 401(k) plan while you’re repaying the loan, so you don’t have the issue of lost opportunity, but you do have to pay that interest.


Q. Since taking out a loan on your 401(k) doesn’t impact your ability to contribute to the fund and since interest rates are so low right now, why shouldn’t we take out a loan for our son’s college education?

Stephanie from El Paso, TX
Submitted via online contact form

ELLIE: There are a number of reasons you should avoid a loan including the fact that it could leave a considerable and even permanent dent in your retirement plan. Most borrowers reduce their contributions or discontinue them so they’ll have enough money to make repayments—it’s just what happens. Also, if you’re laid off or quit your job, the entire balance become due, which could be a double whammy if you suddenly become unemployed. Most employers require repayment within 60 days of leaving a job.

Q. I may be losing my job and I have a loan on my 401(k). I’ve been told I have to pay it back and I don’t see how I can possibly do that. What will happen and what recourse do I have?

Ted Thompson from Denver, CO
Submitted via blog

ELLIE: So sorry to hear about your job situation. If you cannot repay the loan, it becomes a distribution, which means you’ll have to pay taxes on the money, plus a 10% penalty if your under 59 ½. You should go see a free credit counselor at nfcc.org in order to see about paying all your creditors while unemployed.

Q. I’m not real knowledgeable about investing and the stock market. Right now, I’ve been offered two different jobs and part of my consideration includes their respective 401(k) plans. How do I know if a 401(k) plan is any good?

Robert Kavanowsky
New Jersey

ELLIE: Your plan should offer a well diversified mix of low cost investment choices. An employer match is a plus because employees tend to save more when their company kicks in money. So check the amount they are offering on the match. Investment guidance and regular, personalized report cards to show you whether you’re on track are important parts of a great 401(k) plan. Look for a company that is holding the total fees in their plans to well below 1% of assets each year. It’s important for you to choose the managed portfolio in your plan that not only offers low cost index funds, but also suits your retirement plan. If you are a younger worker, under 30, then you might want to go with an aggressive growth fund that is heavily tilted toward stocks, but remember that it also has more risk associated with it. If you are over 55, then you will want to select a fund that is income heavy in order to assume less risk.



Q. How much of my salary should I be putting away each month?

David Johnson, Biloxi, MS

ELLIE: Probably more than you are socking away now! Most employees are saving 7% a year or less and employers that offer matching contributions typically kick in 3$ of pay. That isn’t enough. The old rule of saving 10% of your gross pay was designed in the days when ore people had access to traditional pensions and employer provided retirement savings. In today’s world, you’re pretty much on your own for retirement and should be putting away 15% of your gross salary, including any employer contributions. Workers are permitted to put up to $16,500 in retirement accounts in 2010 and those 50 and older can squirrel away an extra $5500 in catch up contributions. You should have about 11 times your annual salary, on top of Social Security benefits if you want to maintain your current standard of living. So if you make 50K, then you need to save 550K by the time you retire.

Ellie Kay

America's Family Financial Expert (R)

4 comments:

Mrs. Marcus said...

The last question in this post raised a couple of questions/points of clarification. First, I thought you recommended saving 10%. Second, does "saving x%" include matching employer contributions? My husband's job matches up to 5% which would bring us to 10%, but it seems like cheating....

Ellie Kay said...

Hey Mrs. Marcus,

Yes you could count your part AND the matching part as a total 10% savings and many do just that--it's the beauty of a matching portion. However, you still need to save up to 12 months of living expenses in a regular savings account and save for other things such as college funding for kids, etc. So, I recommend that you save that 5% in your 401(k) and then another 5% into one of these other savings vehicles. That way you are still saving 10% of your income, but you get the benefit of 15% savings because your husband's employer is so generous!

shawnagale2000 said...

Ellie we have an adjustable rate split mortgage....as you can imagine our payments have almost doubled....Is there a formula you can use (or perhaps a percentage of our income) that helps you decide if it is time to put up the white flag of I surrender and just let our home go back to the bank....

Ellie Kay said...

Hey Shawna,
Sorry to hear of your situation. I think you should go to www.makinghomeaffordable.gov and get the mortgage adjusted. This is a special program put into place by President Obama's administration to help people get their mortgages adjusted. You'll be paired up, for free, with a HUD certified officer who will help. This should (hopefully) allow you to stay in your home.

Ellie Kay