With the economy struggling and restricted lending now commonplace, many people are treating their 401(k) plans as rainy-day funds. As of late 2010, nearly 28 percent of 401(k) account holders had loans out against them, according to Aon Hewitt.
This record figure has since continued its upward climb. Only in an emergency should someone borrow money from a 401(k) plan.
Close to 70 percent of people who have a loan against their 401(k) plans will default. When this occurs, the loan amount converts to taxable income. Borrowers under age 59 ½ will also need to pay a ten percent penalty for early withdrawal.
Not to mention the huge impact this situation makes on potential earnings in the account.
The government is aware of the situation and two senators have proposed legislation addressing the issue. The SEAL Act is intended to prevent 401(k) account holders from using their plans as rainy-day funds. If it is passed, it will limit outstanding 401(k) loans to three per account.
Participants will also be permitted to continue plan contributions after taking a loan or hardship withdrawal.
This act will also ban the linking of debit cards to a 401(k) plan. Account holders have much easier access to fast cash when they have a debit card linked to their retirement account. Even if the law is not passed, an individual should avoid making use of this feature of the 401(k) plan if it is available.
Retirement plans should not be treated like cash advances. Borrowing form a 401(k) plan to buy a new flat screen TV or pay for a night out on the town is poor judgment. So is using the money to pay off credit card debt because if the spending habits resume, the individual will have new credit card balances plus a 401(k) loan to pay.
