The Bottom Line: Let's change the 401(k) rules

I don't have a 401K yet

Here's to planning for the future Beth-Just one day at a time J. ; ) Cheers!

I agree, to a point. I have a 457K plan. I retired early and am receiving a 20% tax penalty. If I could find a permanent part time job, I'd quit taking money out of my 457!

I began this when it was first offered at work--and I started with $10 a paycheck.

Kim, I haven't checked out Mike's suggestion of 72(t) distributions yet, but it sounds like it may be just what you're looking for. Please do keep us posted on what you find!!

72(t) require you take a systematic stream of income from IRA. There are several ways to calculate the amount. You must take it out to age 59.5 or 5 years whichever is longer. Once you begin you cannot stop or it is considered a distribution. The strategies and calculatiions are tricky and you should contact an advisor who has had experience setting these up.

For example if you are 30 years old you are required to take the withdrawal for 29.5 years (to age 59.5). If you are 57 years old you are required to take the withdrawal for 5 years. Very tricky calculations and not for everyone- you need to talk to someone that understands theses thoroughly.

Not in my realm. Since I could retire early(age 50), I could start taking it out at that time without a penalty. But the penalty comes in if the amount I'm taking out will "dry up" the account in under 10 years.

OH--and this is in addition to my pension -- which, since i worked for 27 years, is approximately 67% of my pay. That's why I said if I could find a part time job, I'd let it sit for a couple of years--the pension is much larger than my 457K plan.

Here's wishing you luck on finding that perfect part-time job Kim. I'm keeping my fingers crossed for you.

I have one but it is pretty much breaking even this last year or so, even losing money now and then.  Waiting for the market to pick back up again (hopefully).  I have a ways to go before retirement anyway!

Indeed, cashing out now would wipe out any chance you now have to recoup your lost stock balances when/if the market fully recovers. Good point that anyone should consider when making the decision to cover costs for the shorterm or down the line (ideally, at retirement).

I took the advice of my agent, which was to basically treat the money I invest in the account each month as "gone", much as I would if I ate a meal out.  The money is spent, gone -- if I get something back for it I am doing well and can enjoy that.  If I break even or "lose" some of my initial/continuing investment, I can't let that get me down.  People often forget that they shouldn't invest more than they can afford to lose!

RE: they shouldn't invest more than they can afford to lose!

So true! Excellent advice Mary.

All of the retirement plans are being looked at so they can be revised into just two options one you pay the IRS tax first so you don't need to pay it when one retires and the other you don't pay the IRS first but do when you retire.

Housing down payments, education and other emergency withdrawals are also being reviewed.

When the analysis is completed I feel congress will pass something close to what you are suggesting and desire.

Interesting analysis Richard. Thank you so much for filling us in on your observations.

I agree that it is supposed to be a retirement fund, not an emergency or I didn't save enough fund. There is a reason for the penalties and while I can see lowering them somewhat, I don't think that they should go away entirely.

I completeley agree with you.  I have my 401K, CDs, and other things that are my retirement savings.  I also have a very healthy emergency fund.  I wouldn't even considering touching my retirement accounts.  I worked too hard to get where I am to get with penalities and high taxes to touch it.

Excellent points. Here's what I proposed in my response to Mike below:

"Absolutely agreed, in principal. In reality? I know people who have just had to tap these funds, and that penalty adds so much insult to injury. Perhaps there should be a course that reviews their options first. If they go through the course, and find that tapping their 401(k) is their only remaining option, then an exemption to the penalty could be offered."

Your thoughts?

Not a bad option, but are we talking a long course? I don't even know why I ask that to be honest. I just think that people are so busy thinking that tomorrow is going to get better, that they put off touching the 401K until it is an emergency or what they call an emergency.

At this point I'm considering the solution would look something like the credit counseling course required by the federal government through the bankruptcy process. It's a half hour to an hour, can be taken online, and comes with a certificate of completion that is then turned over the trustee before a decision on bankruptcy is made.

But, in this case, the course would help you check off your list the various funding sources you could turn to in your time of need before tapping your retirement funds. As this "counseling" grows, it could be tied to an automated application process for each of the options that may apply.

For example, I just found out that in Oregon state, if you make less than 80 percent of the median income that you qualify for a savings match program funded by donations to the state. You save $1 for education, operating a business, or home construction, and the state program matches $3. That is the kind of information that should be getting in front of the populace that needs it most!!!

Wow, that sounds like a great program! You are right, people need to know what is out there so that they can make an informed choice on what to do.

It is funny, we complain about how much the government spends, but most of us never to bother to search for the programs that are out there to help us, not just the dirt poor. I am totally guilty of it. Of course the problem with getting some sort of education problem out there is ....spending more state/federal money to do it.

....unless citizens like us step up to fill the gap. The options are already out there and fully explained, it's just a matter of providing an online clearing house that's easy to navigate and easy to find online. Please feel free to contact me at info@self-directed.info if you're interested in working on the development of this idea.

I don't have 401k

One of these days Renee? The big advantage of the 401(k) used to be that the company you worked for would match your contributions. Sometimes those matches were as low as 3 percent of your contribution. Other companies though might match 100 percent.

However, with the current economy we're seeing more companies scaling back or eliminating their retirement account match. Sooo, long story short, feel free to start your own IRA instead. It offers the same pre-tax benefits (the Roth IRA is a little different, offering no taxes on withdrawals but no tax credit up front) and can be created and funded by any one who makes money outside of an employer relationship.

We would only tap into our 401K if it was an absolute emergency. With the economy the way it is today, one just never knows what to expect.

So true. You've been wise in how you've handled your 401(k) savings Connie.

A couple of points, if you leave your company you can roll your 401k plan or 457 plan to an IRA. If you need to create an income stream pre-591/2 look at and understand 72(t) distributions. You can take a systematic payout for 5 yrs or to age 591/2 whichever is longer. You will pay taxes on your withdrawals but not early penalties.This requires serious consideration and should be discussed with your CPA or financial adviser.

You can take money out of your IRA to pay for education puposes before 591/2 penalty free, not tax free. Make sure you have documentation to justify.

Roth 401k's are now being offered funded with after tax money and withdrawals are tax free.

Retirement accounts should be regarded as that, for retirement not something tapped or borrowed from. They carry benefits of tax defferral and the penalties are they to dicourage you from using them until time.

Part of the problem with 401k's is the responsibility of understanding them is with the employee. When questions come up they go to HR and speak to someone who probably understand as little as they do. While you are limited as to withdrawals from 401k's while employed, people tend to use the loan provision. They borrow from their account and have to pay it back at a certain interest rate over a period (5 years for most reasons, 10 for new home). The problems come with many can not pay back loan and make contributions so the contribution is dropped. Also if you leave employer you still are responsible for loan payment. Defaulting is the same as early distribution ( penalty and taxes). You cannot roll the loan from one employer to another or to an IRA.

Excellent synopsis of the problems that can occur when borrowing from a 401(k). These loans do provide one option though, where if you do pay them back on schedule you'll not only save on taxes and early-distribution fees but you'll also be paying part of the interest back into your own account rather than handing it over to an outside lender. A win-win for the accountholder's bottom line in that repect.

I think under emergency medical circumstances one can withdraw from their IRA without being penalized if a doctor writes a letter and you present it.  Unless those rules have changed.

That is true. But what about emergency unemployment situations? No such exemption.

Disability waives IRA distributon penalty, but it must be on the level that qualifies for SS DI.

No exemption for being out of work

IRA withdrawal guidelines do allow this exception: Those that can show "immediate and heavy financial needs" can request a hardship withdrawal without penalty. Perhaps this should be expanded to 401(k)s as well.

The statement is there but the IRS definition of a hardship does not exist. Being unemployed does not qualify as a hardship. being broke doesn't qualify. Very few waivers of 10% are actually accepted (disability being one, also to pay premiums on health insurance (IRA only) if collecting unemployment  12 weeks or longer, higher ed or first time home purchase.

A plan like a 401k or 457 may, but not requiired to offer specific hardship withdrawals. It must be specific as to what is considered "immediate and heavy". (www.irs.gov)

thanks for sharing

Huby and I both have 401K's they are  just confusing to me, I let him handle all of it. Good article Ms M