Minnesotans are jeopardizing retirement funds by raiding 401(k) plans

As many people in Minnesota and around the country continue to tighten their financial belts, funds set aside for retirement starts looking pretty tempting. It is estimated that one in four Americans are borrowing from their 401(k) plans.

Many workers in the U.S. set aside savings for retirement through employer-sponsored retirement savings accounts. The Internal Revenue Service (IRS) created 401(k) plans - also known as defined contribution pension plans - as a way for employees to accumulate tax-free money. Contributions to 401(k) plans are deducted from paychecks before taxes are calculated. When employees withdraw funds after retiring, they are taxed as the funds are used and they are typically taxed at a lower rate.

Unfortunately, the recession has caused high levels of unemployment, foreclosures and bankruptcies. As individuals try to forestall financial difficulties, they often turn to their retirement plans, such as IRAs and 401(k) plans, to help pay their bills during the tight times.

Robbing Peter to pay Paul

While it may look like a good option to many individuals, borrowing from retirement savings is like shooting yourself in the foot. If you are unable to afford your current bills while collecting a paycheck, you need to ask yourself how you intend to pay your bills when the paychecks are no longer rolling in.

Additionally, borrowing from yourself is similar to borrowing from any financial institution; you must pay interest and the loan must be repaid with after-tax money. That after-tax money is, then, taxed again when withdrawn after retirement.

Most people who borrow from their savings plans, stop funding those same plans until their loans are repaid. This further derails their savings plans as they approach retirement.

Look before you leap

If you are still tempted to borrow money from your future self, do the following first:

  • Check with your employer's plan administrator to find out if you are allowed to borrow from your plan
  • Calculate the interest you must pay for the loan and set up a realistic repayment plan
  • Assess what penalties you will incur if you lose your job before the loan is repaid
  • Remember that money taken out of a 401(k) is no longer protected by filing bankruptcy

Other options are available

If you are struggling with financial difficulties, consult an experienced debt relief lawyer who can help you preserve your retirement savings. You may have a number of options available to you such as:

  • Filing for bankruptcy - which may allow you to erase unsecured debts and save your home
  • Debt consolidation - making your payments more manageable
  • Loan modification - allowing you to keep your home