Hands Off: Don’t Raid Your Retirement Accounts! by Fred Banyon

banyon_smAfter the Great Recession of 2008, an unpleasant phenomena resurfaced.

Because of financial distress from the recession, a large number of Americans began tapping into their secured retirement savings. African-Americans and Hispanics were the groups that dipped into these sacred instruments the most.

According to a 2012 study by Ariel Investments and AON Hewitt, African-American employees took these “hardship withdrawals” more than any other ethnic group. Fully, 8.8 percent of African-Americans took hardship withdrawals in 2010 as compared to 3.2 percent of Hispanics, 1.7 percent of whites and just 1.2 percent of Asian workers.

Because these assets are designed for use in retirement, Americans need to develop sound budgeting and savings strategies that eliminate the need to tap into retirement funds.

Instead of tapping those retirement funds, it is important to use the prosperous times to create a rainy day fund. Many leading financial planners suggest such a fund equivalent to six months salary set aside for an unforeseen emergency.

Hardship withdrawals are allowed from 401(k) plans, but — from what I’ve discussed with Arthur Don, an attorney affiliated with Ariel Investments — there are some amazing things people will justify for such a withdrawal:

  • a vacation;
  • celebrating a wedding anniversary or birthday;
  • paying for a wedding;
  • buying a new car (while this is possibly a necessity, it can often be little more than keeping up with the Joneses);
  • a shopping spree.

There are other reasons, but the point here is that a nonemergency purchase should not come from something as important as a 401(k) plan. Develop better spending and saving habits.

Not budgeting carefully – and thus living beyond our means – is the number-one obstacle toward financial security.

Below are five questions to ask before initiating an emergency withdrawal from retirement savings:

  • What’s the tax bite on a 401(k) withdrawal as opposed to a loan? Any withdrawal from a qualified retirement plan is subject to a ten percent penalty and one’s income tax rate. Be cautious.
  • Can a tax penalty for an emergency withdrawal be avoided? It’s possible for those 55 or older, those who have left the employer where their plan was located, the disabled and military reserve personnel called up to active duty.
  • There’s a risk with losing one’s job. If someone with a 401(k) withdrawal leaves his job or is laid off, any loan balance must be repaid within 60 days.
  • Will I mind my account being in the slow lane for six months or more? One is usually restricted from making contributions to a 401(k) for six months after taking a hardship withdrawal, further setting you back in accumulating retirement reserves.
  • Is there an IRA alternative? Consider a Roth or traditional IRA. There are income tests to qualify, but those are worth a look. An IRA can be tapped into — avoiding penalties — for first-time homebuyers and to pay for college tuition. An old 401(k) can often be rolled over into an IRA.

The best strategy, of course, is to leave a 401(k) retirement savings account alone.

It is meant to provide for the needs of the future, not the wants of the present.

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Fred Banyon, a financial literacy advocate, is a stockbroker with American Trust Investment Services in Chicago. Comments may be sent to [email protected].

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