In the past when Americans got into a financial crunch, they were able to tap into the value of their homes by taking out home equity loans or by refinancing their mortgages. Today, following the collapse of the housing market and in the wake of tightening loan restrictions by banks, they are increasingly turning to a new source of money when they get financially trapped: their 401(k)s.
Size of the problem
This change has been notable. In fact, today the government collects 37 percent more money from penalties for early withdrawal from 401(k) plans than it did 10 years ago. In 2011, this figure amounted to some $5.7 billion in penalties collected. While this extra revenue may be good for the tax system, it spells disaster for the future retirement accounts of average citizens.
According to Time magazine, a new study indicates that the problem is worsening, with 1 in 4 people suggesting they may need to tap into 401(k) or other retirement programs for current expenses. In 2010, early withdrawals approached $70 billion, nearly one-quarter of contributions made that year in total.
Current state of affairs
Unfortunately, for the vast majority of people who need to access this money ahead of retirement, often due to situations such as job loss, the penalties come at a time when they are most vulnerable. Thus, the tax penalties and loss to future retirement income levels a double whammy on the individual forced into that decision. And, as statistics show, the average 401(k) holding in the US today is already far less than it should be, with the median 401(k) holding sitting at a mere $24,400.
For many individuals with far smaller 401(k)s, who are cash-strapped and looking for any extra income, there’s often an attitude that the amount they are bringing to retirement from their former job (from cash-outs when they switch jobs) is so small they may as well take the money (and penalties) and run, instead of rolling it over. That, of course, is dangerous thinking for building security for the future. This is particularly so, as about half of all Americans (in a Gallup poll) indicate that they will need to rely on their 401(k)s in retirement, with fewer and fewer people being part of a pension system.
Withdrawing without penalty
Of course, money in tax-deferred 401(k)s can be withdrawn without penalty by those aged 59 1/2 or older, and in some situations, by those using the money for medical expenses. Individual retirement accounts (IRAs) allow individuals to make withdrawals without penalty in the case of higher education and first-time home purchase as well.
Then there is the loan option, but increasingly the loans taken out against retirement accounts are not being paid back. According to Time, in 2012, a record 22 percent of 401(k)s had a loan against them, with defaults on those loans skyrocketing. In short, the outlook for retirement is dodgy at best.