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401(k) Loans – Not the Best of Ideas

With the economy as challenging as it is for American households since 2007, more and more people have been forced to take loans from their 401(k) and 403(b) plans in the past few years. Of the largest fiduciaries of retirement plans, Charles Schwab estimates loan withdrawals averages of 13.7% of active participants, Vanguard reports 16% and Fidelity, the largest 401(k) manager cites a 22% loan rate in 2010, the latest published statistic. According to a Time Magazine article for the same period, penalized withdrawals in 2004 were $36 billion dollars, which increased to $60 billion dollars in the same timeframe, 2010. This does not apply to loans from Traditional and Roth IRA's are not permitted. The reasons for 401(k) and 403(b) loans are numerous:

With higher unemployment in recent years, many families are forced to cut into their retirement nest egg to pay for their children's college tuition since their college savings plans have come up short due to an inability to keep their saving schedule in tact. Many have fallen behind in their bills as overtime and second jobs have been cut back, but their standard of living is not as easy to readily reduce. Many of the prudent try hard to pay off their loans, but in that time they stop temporarily to make further contributions, thus lowering their overall long term projected balance and hampering growth. If you are unfortunate to lose your job and you do have an outstanding loan and don't pay it back based on the terms of the plan, you may _be taxed in the year of withdrawal as ordinary income, plus a 10% penalty if you are below the age of 59 1/2. As financial advisors, we are fielding more questions about this way of bringing quick money into the household. In just about every instance, we encourage our clients to find another source of income. Besides losing an average third of the withdrawal to taxation, you have to think further down the line. Depending on your age, every dollar you take out today may be two or more depending on how many years you have to retirement, causing you to rethink those plans of sunny beaches or world traveling in your golden years. What if you have no choice?

Wait until just after January 1st, giving you a full 15 months until you have to file your taxes and Pay Uncle Sam. If you can, wait until you are above age 59 1/2 to avoid the 10% penalty. There is a little known IRS rule provision known as 72(t) which actually allows you to withdraw money from your retirement plan before that magic age of 59 1/2. It does come with some specifics rules though: you must take equal and periodic payments (annually, monthly etc.) from your plan for a full five years, or until you reach the age of 59 1/2. While we don't encourage it, there are ways to use your retirement funds pre-retirement. If you are thinking of using your golden years nest egg early, give your Chestnut planner a call to discuss it - together, we'll work it through.

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