Resist temptation to dip into retirement savings

March 01, 1992|By Marilyn Adams | Marilyn Adams,Miami Herald

That fat retirement nest egg can look so tempting when times are tough and retirement seems so far away.

But the experts are united on this one: Before borrowing from a retirement plan, try everything else first. Cut back on spending. Sell the boat. Tap checking and savings. Borrow from life insurance. Call on relatives.

Then ask yourself: Do you really want to make a dent in the money that's intended to carry you through old age?

"This is not something to be taken lightly," said pension designer Austin Frye, president of Frye Pension & Financial Corp. in North Miami. "My experience is that very often these loans are not paid back, and then it becomes a very expensive transaction. This should be a source of last resort."

But these days, lots of people, due to layoffs, salary cuts and scarce job opportunities, desperately need that source of last resort. So they're dipping into money that was to be sacred until retirement.

Withdrawing money from a tax-deferred retirement plan isn't easy or cheap. Income taxes must be paid on any tax-deferred money withdrawn. And unless you are at least 59 1/2 years old, a 10 percent penalty will be levied.

Though no taxes or penalties are charged on borrowing against the account, federal rules are strict. In many cases, withdrawing or borrowing isn't allowed at all.

Those who are self-employed or part of a partnership or an "S" corporation are barred by law from borrowing from retirement. An S corporation is a type of business, usually small business, in which profits flow to individuals rather than the firm.

And many retirement plans lack the necessary plan provisions ++ that allow loans to be made. For those considering dipping into this last-resort pool, here are some rules:

* Some 401(k) retirement plans contain a "hardship" provision that allow withdrawals in true emergencies. Those rules depend on the plan. The employee must pay taxes and penalties on the money withdrawn. But after the withdrawal, an employee can keep contributing to the plan.

* Pension and retirement plans that do permit loans have strict rules. If an employee works for a company that permits loans, the worker can borrow up to half the vested pension savings or 401 (k) account, to a limit of $50,000. And the employee is allowed to borrow $10,000 even if that's more than half of vested savings, according to the Association of Private Pensions and Welfare Plans in Washington.

"Most companies allow loans for any reason," said Jean Campbell of Hewitt Associates, a Lincolnshire, Ill.-based consulting firm that advises companies about employee benefits. A 1991 Hewitt survey found 67 percent of large companies had plans with loan provisions. Of those, 92 percent permit loans for anything.

Borrowing against retirement savings can be cheaper and simpler than borrowing from a bank. The usual procedure is to get a form from the benefits office, fill it out and repay the loan through payroll deduction. Interest rates vary from the prime rate, prime plus one or two percentage points to market rates that local banks are charging for similar loans.

Repayment rules can't be broken without serious consequences. Payments on the loan must be made at least once a quarter. The loan plus interest must be repaid generally within five years or less, longer for a home loan.

Mistakes can be costly. "For one thing, it's the first thing an IRS auditor would ask to look at," Mr. Frye said. Taxes and penalties on pension loans are "easy money" for the Internal Revenue Service, he said, because it's so easy for borrowers to make mistakes. If you get audited, that loan is one place an auditor is likely to look for more tax revenue.

Though many pension plans do permit loans, Individual Retirement Accounts do not -- except for extremely short periods of time. Federal rules allow an IRA investor to roll over the investment from one place to another once a year, if desired. The borrower has 60 days to redeposit the funds.

For short-term emergencies, it's possible to tap these funds -- as long as they're reinvested in another IRA account by the deadline. Miss the deadline and you can be charged federal income tax plus a 10 percent penalty. What's more, you can use

the roll-over route only once every 12 months.

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