- The Washington Times - Thursday, September 18, 2008

Banks often want as much as 20 percent down when you buy a home, a big payment that’s often hard to come by. So, it can be very tempting to tap into your retirement account. That decision will cost you in the long run, so it’s something that should be thought out thoroughly before moving forward.

Borrowing or taking a withdrawal from your 401(k) is the topic of this week’s question.

Q: Can I borrow from my 401(k) account to help buy a home without penalty?

Both loans and hardship withdrawals can be used for a home purchase if permitted under your plan. However, not every plan allows such options, so you’ll need to check with your administrator.

First, you may be able to borrow up to 50 percent of your account balance, up to $50,000 and you’ll repay the loan through a paycheck deduction. Most loans must be repaid within 5 years, but loans for buying a home may be spread over a longer period. You won’t be taxed on the loan amount, but you must pay interest on the loan usually a couple of points above prime. Of course, you’ll be paying it to yourself. The drawback is that the interest rate is likely to be less than the returns the funds would have otherwise earned.

If you leave your employer, the entire balance of your loan will be due likely within a couple of months. If you can’t repay it, the loan will be treated as if you withdrew the money early from your account, which means you’ll pay federal income tax plus a 10 percent federal penalty tax if you are under age 59.

The Investment Company Institute, a trade group of U.S. investment companies, says 58 percent of 401(k) plans offer loans, but most workers don’t exercise that option. Some plan administrators have reported increases in the number of borrowers in the past few years, and it appears slightly more than 20 percent of those eligible to borrow have outstanding loans. Average balances were typically around $7,000.

A second option, the hardship withdrawal doesn’t have to be paid back, but it is subject to current-year federal income taxes and, if you’re under 59, the 10 percent early withdrawal federal penalty tax.

To be eligible, you must have exhausted other funds or ways to meet your hardship, including a plan loan, and you can’t contribute to the plan for six months following the withdrawal.

The following items are considered by the Internal Revenue Service as acceptable reasons for a hardship withdrawal: Unreimbursed medical expenses for you, your spouse, or dependents Purchase of an employee’s principal residence Payment of college tuition and related educational costs for you, your spouse, dependents, or children who are no longer dependents Payments necessary to prevent eviction of you from your home, or foreclosure on the mortgage of your principal residence Funeral expenses Repair of a primary residence

Most plans allow hardship withdrawals, but just 4 percent of participants have chosen to do so, the ICI says. About 45 percent of those taking out money did so for a home loan and 28 percent needed the money for a medical emergency.

Linda Wolohan, a spokeswoman for The Vanguard Group, says financial advisers offer a reminder: Whenever you take money from your plan even if you’re paying it back over time you reduce the amount available to grow and compound. In particular, if the market does especially well, you won’t share fully in the gains.

A withdrawal can’t be put back, which means you lose for life the tax advantage on those funds.

An online calculator provided by Bankrate.com can tell you how much money you’ll lose by borrowing from your account. It’s posted on the Web site at https://www.bankrate.com/brm/calc/401kl.asp

An example offered by 401khelpcenter.com illustrates the impact: An employee begins at age 30 contributing $5,000 a year to a 401(k) plan. At age 40, the employee buys a house and takes a $10,000 hardship withdrawal for the down payment. Assuming an 8 percent annual return, the employee would have $793,094 by age 65. Without the withdrawal, the account would have grown to $861,584. The $10,000 loan ends up costing $68,490 in lost earnings.

Q: Should I be considering changes in my 401(k) in response to the rapidly changing financial services sector?

A: If you’ve been watching your 401(k) you likely know there has been a significant impact on your investments from the bear market, a prolonged drop in stock prices often defined as a 20 percent drop over at least two months. The market reaction to Lehman Brothers‘ Chapter 11 bankruptcy protection filing should not push you into selling off stocks in a knee-jerk fashion, said Rick Meigs, founder and president of the 401khelpcenter.com, a Portland, Ore.-based company which advises industry professionals. “What’s going to happen is at some point in time down road, perhaps six to 12 months, the markets will start climbing and you’re going to be out of the market.”

You likely will not be able to anticipate the upswing, which may occur quickly. It’s a basic truism that the market can never be predicted and you could lose out on an opportunity to recapture some losses.

Underscoring that you shouldn’t be reactionary, Meigs said you should look at your asset allocation and rebalance only if you had planned to.

For example, he said, some people may have an overly aggressive investment plan in which all of their money is in the stock market.

If you’re 55 and your 100 percent in stocks, you’re probably too aggressive and you should allocate more money in bonds or other safer investments to spread out chances for loss.

He said the decision about whether to reallocate should be guided by your analysis of risk and how close you are to retirement.

Meigs stresses that you should tinker with allocation only as you might in a normal market.

Otherwise, he said leave it alone and ride out the storm.

In response to the Lehman Brothers announcement, Meigs offers two pieces of advice: Check to see if your 401(k) plan offers financial advice from a professional. Many do. Take advantage of that and discuss your portfolio balance. Ask your 401(k) administrator at your employer typically someone in the human resources department whether you have Lehman funds in your 401(k) plan and if so determine your exposure to financial and other sectors which may guide your rebalancing.

Q: Should I consider converting assets to cash or certificates of deposit, or anything that might be safer than stocks?

Having accessible cash or money in CDs is a good part of a balanced financial plan in the event you need money on a short-term basis, said Diahann Lassus, of Lassus Wherley & Associates, a New Jersey fee-based financial planning firm. But transferring significant invested assets as a reaction to the market is not good planning.

Going to cash and CDs now means “you’ve given up all your gains plus you’re going to miss out on any opportunity when the market recovers,” she said. It addition, you’d pay additional transaction costs to make the change.

Markets always recover, said Lassus, who is chairwoman of the National Association of Personal Financial Advisers. She said it appears the Lehman Brothers case has been handled in an orderly manner and the invested assets will likely be transferred to another company.

The Securities Investor Protection Corp., a nonprofit membership agency that steps in to make investors whole when money or securities appear to be missing in brokerage bankruptcies, said it’s not needed in the Lehman case because no money appears to be missing.

Have 401(k) questions of your own? Send them to: dpitt(at)ap.org

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