Bruce Helmer and Peg Webb

An alarming article in the Wall Street Journal recently reported a growing number of people using their retirement accounts like cash machines — even to cover emergencies. About a quarter of 401(k) account owners who do tap their funds prematurely borrow an average of 11% of their account assets. And even if roughly 90% of those borrowers pay the loans back on time, 1 in 10 will struggle to do so or
simply never pay the money back.

Today’s article discusses why you should always resist the urge to take early withdrawals from your 401(k), either through loans or hardship distributions.

Retirement plans use incentives and penalties specifically designed to keep you from tapping your nest egg until later in life. Contributions to a traditional 401(k) plan are made with pre-tax dollars, meaning if you have a retirement plan at work, you never see the money contributed to your account. It’s deducted from payroll before you get your paycheck.

However, if you take withdrawals from these traditional accounts, the IRS will require you to pay income tax on the full amount, plus often a 10% early withdrawal penalty if you are age 59½ or younger. It’s a strong incentive not to use this money before you retire.

Rules on loans and hardship withdrawals are designed to discourage early withdrawals

Despite the stiff penalties for taking money out early, most 401(k) plans allow you to borrow up to 50% of your vested balance, to a limit of $50,000, and for up to five years. On the surface, it seems like a great deal: Funds can be used for any reason and, because the funds are borrowed and not withdrawn, the loan is tax-free. Even better, you’re allowed to repay the loan gradually — including both principal and interest — and you pay the principal and interest to yourself, often at lower rates than you can get at a bank.

If this sounds too good to be true, it is! We’ll explain why in a minute.

The IRS also allows withdrawals for hardship-related reasons, such as preventing evictions, paying medical and educational expenses, or becoming permanently disabled. Hardship loans are marginally better than traditional loans because they do not need to be repaid. But they do have their own set of rules. For example, the amount of the withdrawal is limited to the amount necessary to satisfy that need. In addition, you’ll be taxed on the amount withdrawn (unless withdrawals are made from after-tax Roth contributions). Finally, you won’t be able to roll the distribution amount over to an IRA or another plan.

The Bipartisan Budget Act of 2018 and SECURE Act 2.0 relaxed some of the rules around taking hardship loans, and that, in part, has made them more popular as sources of emergency cash.

Why taking a loan is not a great idea

From a tax perspective, taking a loan from your 401(k) is inefficient. For one thing, you must pay the loan back with after-tax dollars. This means repayment will cost you more than your original contributions. For example, if you’re in the 24% tax bracket, every dollar you earn to repay your loan leaves you with only 76 cents for that purpose; the rest goes to income tax.

Furthermore, if you take a loan, you lose the earnings on your money while it’s outside the account, creating a huge opportunity cost. If the return on your 401(k) balance is 8% for a year in which you borrowed funds, for example, the effective interest on your loan is 8% — that’s an expensive loan!

Should you lose your job, you’ll have to repay the loan more rapidly — generally by the due date of your next tax return — when you already could be financially vulnerable.

Finally, if you default on the loan repayment, the amount you still owe converts to a withdrawal, and income tax and possible penalties will be due.

The law of unintended consequences

One of the reasons the use of hardship loans has increased is that more employers, to improve retirement security for their workers, are auto-enrolling them into the plans. This means a worker must opt out of their plan if they don’t want to save for retirement. The positive effect is that workers immediately begin to build a nest egg without thinking about it. On the other side, some participants often don’t take the time to understand the rules and penalties that come with participating in a workplace plan and view their 401(k) as a ready source of cash. In fact, according to data from Vanguard, 3.6% of its plan participants took early withdrawals from their accounts in 2023 for financial emergencies, up from a pre-pandemic average of about 2%.

This is not to minimize the very real hardships people were facing. In 2022 and 2023, everyday costs of gas and groceries were going up, and credit card debt began to rise significantly. Nearly 40% of those who took hardship distributions last year did so to avoid foreclosure. More than 75% of hardship distributions totaled $5,000 or less.

In a way, the success that 401(k) plans have recently enjoyed in getting more people to save and invest through auto-enrollment is sowing the seeds of a potential long-term crisis — the retirement savings gap is proving stubbornly difficult to close.

Unless it’s their only recourse, we advise most people against taking a loan from their 401(k). People think they will pay back the loan later, but in our experience, it rarely happens. The tax consequences of paying a loan back with after-tax money erode the value of your hard-earned retirement savings and potentially put you on the sidelines while you service the loan. Moreover, taking a loan could be a red flag that you are living beyond your means and need to consider changes to your lifestyle.

A better approach to the “nuclear loan option” is to build a more liquid emergency fund that will pay for six months or more of living expenses, leaving your retirement fund to build long-term wealth where it’s needed — for your retirement.

Bruce Helmer and Peg Webb are financial advisers at Wealth Enhancement Group and co-hosts of “Your Money” on WCCO 830 AM on Sunday mornings. Email Bruce and Peg at yourmoney@wealthenhancement.com. Securities offered through LPL Financial, member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, LLC, a registered investment advisor. Wealth Enhancement Group and Wealth Enhancement Advisory Services are separate entities from LPL Financial.

In recent days, the inflation indicators have stubbornly signaled that a high tide of prices is still soaking us consumers. Growing at a 3.5% annual rate in March, the Consumer Price Index has now exceeded expectations for three months and running. Once again, investors and financial decisionmakers — and isn’t that everyone with a bank account? — are playing the Federal Reserve guessing game.

What will the Fed and its 500 economists do now? After all, this is an election year. What about President Joe Biden? Is there something his nearly 2 million civilian executive branch employees can do? To Fed Chairman Jerome Powell, the frustrating and painful combination of interest rate hikes and orchestrated reductions in the money supply may be feeling like King Canute’s fabled attempt to counter an incoming tide.

According to legend, the 11th century Viking ruler of England, Denmark and Norway sought to prove to his fawning royal staff that, as much as they wished otherwise, even their king could not control the tides. Canute had his throne moved to the edge of the sea and then ordered the tides to halt and not wet his feet and robes. Of course, the tide paid no attention, and the king retreated to higher ground.

After admonishing his subjects not to expect unyielding forces to obey his commands, Canute proceeded to take other actions that would make life more pleasant. He set to work reducing tariffs and taxes imposed on his people when they made important pilgrimages to Rome and devoted his energies to other beneficial changes, all of which focused on policies that he could actually control.

Maybe Fed Chair Powell should admit that the Fed is not able to bring about calculated and systematic reductions in the price level at this time. Unpopular as it may be, perhaps he should admit that after the government spending spree that began during the pandemic and distorted the money supply, the inflation tide will ebb and flow. It seems clearer by the day that as long as Congress and the president continue to spend drastically more money than the nation takes in, they’ll fan inflation’s flames and make Powell’s job extremely difficult at best.

Lacking a king’s authority to deliver other policy benefits, Powell can only hope that Biden will also follow Canute’s lead. But Biden seems to be playing the opposing hand. Apparently believing that he can control the tides, Biden has launched a “Strike Force on Unfair and Illegal Pricing,” this in addition to his earlier efforts to jawbone the economic powers of the world into bringing down prices.

Yet while pushing his throne closer to the edge of the sea, Biden has also increased consumer prices by imposing higher tariffs on imported steel and automobiles. He’s marched with UAW workers to gain increased wages, which tend to push prices higher. And he’s happily canceled more than $7 billion in student debt while arguing that the burden was limiting former students’ ability to buy homes and other consumer goods. That ability, if bolstered, would also tend to push prices higher.

With Powell watching and no doubt hoping for beneficial results, Biden is sitting in his figurative throne waiting for inflation’s incoming tide to obey his command. Meanwhile, his almost countless staff members are cheering him on. When will Biden pull back from the edge and take other inflation-limiting actions?

Bruce Yandle is a distinguished adjunct fellow with the Mercatus Center at George Mason University, dean emeritus of the Clemson University College of Business & Behavioral Science, and a former executive director of the Federal Trade Commission. He wrote this column for Tribune News Service.

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(Courtesy of the author)

Rain Taxi Review hosts an evening titled BANneD Books on May 3, its second annual event at Granada Theater in Minneapolis. This fundraiser for the nationally circulated literary journal will be a program of words and music, including musicians The Muatas, Willie Wisely and author/artist Zak Sally, former bassist for the Minnesota band Low, as well as readings by multi-talented Dessa and poet Danny Klecko.

Carolyn Kuebler (Courtesy of Rain Taxi Review of Books)

Special guest will be Carolyn Kuebler, who will launch her debut novel, “Liquid, Fragile, Perishable,” at the event. Kuebler has deep roots in the Twin Cities, having co-founded Rain Taxi Review of Books with Randall Heath. When she left Minnesota in 1999, Eric Lorberer took the helm of the Minneapolis-based publication that also sponsors readings and the popular Twin Cities Book Festival.

Kuebler, who edits the New England Review at Middlebury College in Vermont, recalled for her Melville House publisher her years in Minnesota:

“When I moved after college I had no idea what an indie press was, much less that the Twin Cities were such a hotbed for them. But I spent a formative decade there in the 1990s, and had my first publishing internship at Milkweed Editions while I worked downstairs at the Coyote Cafe. I later became a bookseller at Borders in Uptown (Minneapolis) a few years and wrote book reviews and other features for the late great City Pages. I then made my way to the Hungry Mind bookstore in St. Paul, where I was second-in-command for events — which at the time happened multiple times a week. David Unowsky was great at giving us a lot of creative freedom there, so I also made lots of displays and ordered lit journals. Most significantly, and thanks to Eric Lorberer most lastingly, in 1996 I started Rain Taxi with a couple of friends, and we published the first issue in 1997. I look back on that time as a kind of literature and publishing grade school, with a very self-directed program. I used to love riding my bike from Minneapolis to St. Paul, swimming and walking around the lakes and checking out shows at First Avenue and 7th Street Entry. The John Ashbery bridge from the Walker Art Center to Loring Park epitomized my sense of what the cities were all about.”

Kuebler’s novel, “Liquid, Fragile, Perishable,” tells the story of three young women in a small Vermont town with characters including newly transplanted New Yorkers who are among well-to-do couples building giant houses in the rural area, an old-school and decent Christian beekeeper whose wife keeps their daughter on a tight leash so she isn’t contaminated by girls at the local high school, young people from a hardscrabble family with few morals, and a lone and aging woman who believes she can live by herself even if it means walking six miles carrying groceries. All their lives are affected when the newcomers’ son falls in love with the beekeeper’s daughter.

The novel, one of Oprah Daily’s most anticipated reads of 2024, earned a starred review in Kirkus: “At times dark, at other times beautiful, Kuebler’s debut shines in its precision. It picks apart each character’s thoughts in an unusual clipped stream-of-consciousness narrative. The characters’ points of view fit together like an elaborate quilt, gradually coming together into a satisfying whole.”

Event details: 7 p.m. Friday, May 3, Granada Theater, 3022 Hennepin Ave., Mpls. General admission $30; VIP ticket for two $150. Tickets can be purchased in advance at: raintaxi.com/rain-taxi-fundraiser.

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