401(k) and 403(b) Loans - Yes or No?

The issue raised by recently released study** is whether employees are given the financial tools, including unbiased guidance, to make the best decisions concerning their retirement assets. According to the researcher*** of this study, these data strongly indicate that, for many workers, investment advice is misaligned with workers’ investment needs and their basic day-to-day financial needs.

The study released by the independent consumer research group shows that 1 in 4 Americans will access their retirement plans before their reach retirement, now withdrawing $70 billion annually. They will either cash-out their savings before retirement – incurring substantial penalties and taxes (10% IRS penalties if you take money before age 59 ½ and, depending on investment vehicles, significant surrender chargers) – or take loans and expose themselves to double taxation (though your contributions are being made before taxes, the loan is repaid with after-tax dollars and you will pay again taxes on this money when you start withdrawing retirement assets during your retirement), fees (there may be initial set-up and quarterly fees) and losses of potential higher earnings within investment options (e.g. you pay yourself back at 5% interest rate but may have been able to earn more if you left the money invested).

The study focused on workplace-based plans, primarily 401(k) and 403(b) plans.

The research also finds that only 8 percent are withdrawing funds because they have lost their jobs. Instead, 75 percent of those who have made early withdrawals have done so because they lack basic money management skills. In many cases, better planning and professional guidance would put them on a track to avoid costly mistakes, take advantage of the tax incentives, and accumulate the savings needed for retirement.

Unfortunately, my own experiences working with employees of public, private and non-profit organizations are pretty much in alignment with the findings of this study. What is even more disappointing is that many big organizations including well-known companies and school districts are providing very limited or even inadequate financial services to their employees using only services of the selected group of vendors. The most surprising is that the majority of employees trust more their employers than their own judgment or independent advice when comes to managing their own money. The lack of proactive approach and initiative in managing their finances and learning more about their options outside of what is offered by their employers is extremely surprising.

One of the most common mistakes is that workers are choosing inappropriate investment vehicles based on their age, risk tolerance, objectives and time horizons. The second most common mistake is taking 401k and 403b loans without fully understanding how they work and the real cost of these loans.

We live in the era of “get as much free stuff as possible” and this includes the money as well. Much has been said about so called “free dollar” and every reason in the world to take advantage of it. For every dollar you contribute to your 401k your employers will contribute their money. Employer’s matching contributions vary. Many of these plans have so called vesting period- a waiting period before employer’s contributions become legally yours. Also, it is important that you read carefully and fully understand what is known as the company's stock options plan and the options agreement to determine the rights and key restrictions available to employees.

In order to take advantage of their employers’ contributions, employees will go to extremes and put all the money they can save in their 401k accounts. Basically, they use these accounts and the funds which otherwise should be protected assets as “all-purpose” saving accounts.

Don’t let greed, lack of knowledge, initiative and proper financial planning stand in the way of proper allocation of your assets and the implementation of prudent retirement and financial plan. Reach out and seek an independent professional assistance. I will be happy to guide you in your decision-making process. I specialize in retirement and financial planning - so you can focus on what you do best: your work and your business.

_________________________________

**HelloWallet January 16, 2013

*** Matt Fellowes, HelloWallet Founder and CEO