'Other Resources' Seen As Preferred

April 7, 2008
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GRAND RAPIDS —Taking money out of a 401(k) has to be a last resort and “the final, final, final resource” an individual should tap for emergency funds, says Scott Bernecker, first vice president and wealth management adviser at Merrill Lynch’s Grand Rapids office.

Bernecker said there’s definitely more 401(k) withdrawal activity going on today than his company has ever witnessed in the past. But 401(k) loans and withdrawals are major mistakes because no matter what the individual does, he’s going to be penalized for it.

“If you take money out of your 401(k) prematurely, you’re automatically hit with a 10 percent penalty and then you’re also taxed as though it’s ordinary income, so in many cases you’re 35 percent in the hole before you even get to see your money. Those are just the short-term ramifications. The long-term ramifications of raiding your 401(k) far outweigh anything in the short term. We highly, highly recommend that people find other resources.”

Most people don’t even realize that taking $10,000 out of their 401(k) can hurt them in the long term, Bernecker said. It hurts because at the end of the day, that $10,000 turns into $7,000.

It’s easy to calculate beforehand what the financial impact of early withdrawal will be, and Bernecker encourages anyone contemplating a 401(k) withdrawal to go through the calculation process with their financial planner or adviser. 

Although 401(k) loans and withdrawals are a concern, most plans these days — at least the ones Bernecker sees — simply don’t allow for distributions for anything other than hardship. The average person who needs, say, $20,000 in cash in many cases can’t get at his money unless he retires, resigns or is terminated from employment, so early withdrawals and loans have become more difficult, he said.

“Of the plans we have set up in the last year, less and less of them are allowing withdrawals other than for hardship purposes, and less of them are allowing loans,” he noted.

Dori Drayton, who leads Plante & Moran Financial Advisors’ Western Region Corporate Retirement Plan Practice, said that Plante & Moran really hasn’t seen a dramatic increase in 401(k) loans or withdrawals.

“I think a lot of it is because the plan sponsors we work with are really being proactive in coaching their participants about the fact that a 401(k) is a retirement plan, not a savings program, and they should do what they can to keep their money in the plan and keep it invested,” she said.

Drayton also thinks it’s because a lot of Plante & Moran clients have been fortunate in that they haven’t had those “Michigan downturns” in their businesses.

People should seriously look at their situation to determine whether it’s truly a “hardship,” Drayton said. Very often it’s not: More often than not, people are just living beyond their means, she observed. But if it truly is a hardship, sometimes people don’t have any other choice than to raid their 401(k) — especially now that banks have much higher lending standards than just a year ago. And people can’t leverage their houses like they once were able to do with home equity lines, Drayton pointed out.

“But there is a serious problem nationally with people not saving enough for retirement,” Drayton observed. “It’s very scary for those of us in the business, especially when we see deferral rates of 2 percent: You can’t just save 2 percent of your salary and expect to retire on it.”

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