The current financial and credit crisis has caused an unprecedented rise in unemployment rate and has put many households on the verge of survival. Being forced to live with an even tighter budget, many people have considered borrowing from or liquidating their 401k plans. And although 401k is a retirement plan and not a savings account, the government has allowed to more than 85 percent of workers to borrow from their 401k plans.
Although in tight financial times requesting a 401k hardship loan or liquidating a 401k plan seems like a reasonable solution, there are some important considerations that need to be addressed.
(1) Solvency in retirement years is being put at stake
As already explained, 401k is a retirement plan that aims at ensuring solvency in the retirement years. Cashing out the 401k to pay off current debt is in the 99.9 percent of the cases a bad idea. The money one saves today will be valuable in the years that this person won't be able to work anymore. If, in the future, they get sick and they cannot work past a certain age, they will need this money to fall back on. Unless, there is a feasible plan to replace the money that is spent today, chances are there will be no money in the future at all. But there will be no option to work as well. And this will make retirement years tougher.
(2) Start over from the bottom
By liquidating 401k, in effect one starts over from the bottom and the older one gets the more difficult it becomes to rebuild a fund. Younger people can work at two jobs, have better mentality, stronger stamina and are more determined to achieve. As people get older, they lose their patience, their vision and, most importantly, their will to fight for establishing things. At an older age, one is supposed to enjoy what one has built at a younger age. And everything becomes harder without money.
(3) Unemployment benefits are deferred when a 401k hardship loan is allowed
When a worker is allowed a 401k hardship loan, the government considers the money as income and when the whole amount runs out the person is not eligible for unemployment benefits. People who have managed to collect unemployment and withdraw 401k funds were required to pay back the benefits received.
(4) Liquidating is subject to severe taxation and penalties
If one liquidates before the age of 59 1/2, the retirement funds are subject to taxation and 10 percent penalty payment. This is another reason why young people should not consider liquidation of their 401k plans, but even if they do they should be sure to calculate taxes and penalties correctly with a tax preparer in order to avoid additional charges in their already difficult financial situation.
By and large, there is no doubt that liquidating 401k plan before the retirement age is a bad idea. It may make financial sense today, but in the future it can harm one's financial health. 401k is perhaps the only way to get out of financial problems in retirement. By liquidating it or borrowing from it, people put themselves on a constant circle of debt, financial insecurity and insolvency. If there is seemingly no alternative option than liquidating 401k, consulting a financial adviser is a great way to get out of financial issues so that 401k plan is kept safe while people are still working to get out of debt.