The Latest Borrowing Vehicle: your 401(k)

By Reuters Staff
February 28, 2008

Can Americans be trusted to save for their own retirement? A data point released today suggests not. But first a quick primer on the two basic types of retirement plans: defined BENEFIT plans and defined CONTRIBUTION plans.

The basic difference between the two is who bears investment risk. Is the employer or employee responsible for investing contributions today in a way that will provide sufficient retirement resources tomorrow? Employers bear this risk with D.B. plans. Employees take on the risk with D.C. plans.

Personally I prefer D.C. plans because I get to control my own retirement savings. And I get to take them with me if I change jobs. But it remains my responsibility to make contributions and to invest the contributions prudently.

401(k) plans are a common type of defined contribution retirement plan. Your employer matches contributions you make and you’re responsible for investing the proceeds, often in a menu of mutual funds. If you change jobs, you bring the proceeds from your 401(k) with you, by rolling them over into an IRA, for instance.

The above is just meant to explain how, as employers are shifting towards D.C. plans, individuals are called on to take more responsibility for their own retirement savings. But as in so many other aspects of their financial lives, Americans are proving increasingly irresponsible with their 401(k)s.

Here’s a gem from the latest report of the TransAmerica Center for Retirement Studies:

The economy isnt just preventing employees from saving more for retirement the study shows that it is also starting to affect what theyve already put away. This years survey revealed a noticeable jump in employees taking out a loan from their retirement plans: nearly one in five (18 percent) in 2007, up from only 11 percent in 2006. Nearly half (49 percent) of those who took out a loan cited the need to pay off debt a significant increase from 27 percent in 2006.

While a loan from your 401(k) plan seems like an obvious choice when youre in need of money, many are unaware that this short-term solution can often create more problems, said Collinson. Once you terminate employment, most retirement plans require that you repay the loan in full or it will be considered a taxable distribution in which regular income tax applies and, if you are under age 59 ½, an additional 10 percent penalty applies.

What a rude awakening it will be when Social Security goes bankrupt and that won’t be there for retirees either.

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Comments

Nice comment.Thanks for sharing.

 

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