December 21, 2007 - The final weeks of the year and the first two or three of a new year are the time periods during which most people tap into their 401(k) retirement plans. Perhaps it has something to do with new year resolutions.

With the Fed's recent cut in interest rates and the drop in primary and second home prices in many parts of the country, Americans seeking to buy property are looking to their 401(k) for money. But your retirement plan should be far down on your list of potential sources.

Hardship Withdrawals

The IRS allows financial hardship loans for very narrow and specific reasons. They are:

• To pay for unreimbursed medical expenses, but only for you or your dependents.
• To prevent foreclosure from your home (or eviction).
• To buy a primary residence.
• To pay college tuition (and approved related education costs) for you or a dependent.

But a hardship withdrawal is not an automatic thing. First of all, individual employers can impose tougher restrictions. Or, they can completely bar such withdrawals. Let's examine some of the issues.

The negatives surrounding hardship withdrawals...

• You must pay income tax on the entire amount that you take out.
• If you are under age 59 ½, you must also pay a 10% early withdrawal penalty, with rare exceptions.
• You'll be asked in-depth personal questions about why you need the money. Many employers insist that you prove you've exhausted all other sources of money, such as a bank savings account, a brokerage account, mutual funds, CDs, EE Savings Bonds and U.S. Treasuries.
• You will be giving up part of a key asset. Federal law protects your 401(k) from creditors. So if you were to file for personal bankruptcy or go into foreclosure, your 401(k) would be safe.

Finally, you're obviously depleting money specifically set aside for your retirement.

Now that we've laid out the pertinent details about a hardship withdrawal, let's look at a 401(k) loan.

Most plans allow employees to borrow up to $50,000 or 50% of the amount invested in the plan, whichever is less. And the interest rate is low, compared with other types of loans -- typically 1 or 2 percentage points above prime. And, you'll have five years in which to pay it back.

Negatives of 401(k) loans...

Again, you're obviously depleting money for your retirement. The growth of your 401(k) is directly hampered by the amount you take out.

Equally important is the fact that if you leave your job or are fired, you must repay the loan, and fairly quickly. Most plans insist upon repayment within 30 to 90 days after your final day of work.

If you don't repay the money you will be hit with taxes on the outstanding dollar amount.

For Further Information

You'll find a wealth of information at: www.401khelpcenter.com

- Nancy Dunnan

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