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Prevent Clients from Retirement Disaster

Last year, one out of three 401(k) participants used a plan loan or hardship withdrawal, according to a recent Financial Finesse study. That was a substantial increase from 2011, when only one in four participants completed such transactions.

In many instances, hardship withdraws and loan can have adverse impacts, such tax implications and missed market opportunities, on long-term savings goals. For advisors, this development can be frustrating. Yet, this trend can present attractive opportunities for advisors.

First, advisors can help clients take actions—such as creating budgets—that may help them avoid tapping their retirement plans. Second, advisors can make sure clients who take loans and withdrawals are aware of the potential pitfalls of doing so. They can also help clients from making costly mistakes when they do tap retirement assets.

In some cases, of course, a plan loan may be more attractive than resorting to high-interest-rate credit cards for financing. The important factor is for clients to fully understand the ramifications of taking loans or hardship withdrawals and understand what other options they may have, such as using a home equity loan.


Advisors can take various actions to help their clients avoid the need to use retirement assets prematurely. Many advisors may have already taken many of these actions, such as ensuring that clients have reasonable budgets, emergency funds invested in liquid assets, and manageable debt levels. In short, those provisions are the basics of sound financial planning. Yet, advisors can also take other measures, such as recommending that their clients establish a home equity line of credit as a source of emerging funding as an alternative to 401(k) plan assets.

Advisors should also help clients who tap their retirement plans avoid the potential pitfalls associated with hardship withdrawals and loans. For example, employees must repay their plan loans within five years. If they fail to do so, the loan is considered a distribution, which is taxable.

In addition, if the employee is younger than 59 ½, a 10% early withdraw penalty will also apply.  Employees who either lose their jobs or change jobs must repay their loans within 60 to 90 days to prevent the loans from being considered early withdraws.

Clients considering taking a hardship withdrawal, meanwhile, should be advised that taxes and the 10% early withdrawal penalty may also apply. The penalty may be waived in some cases, such as for certain medical expenses, permanent disability, court ordered payments to a spouse or dependent, and termination of employment at age 55 or older.

The penalty tax that can apply to loans that aren’t repaid on time and to hardship withdrawals is only one consideration. Indeed, a greater loss may be a result of the assets that have been withdrawn from a plan not being exposed to market appreciation. With that in mind, advisors may want to illustrate to their clients the hypothetical impact of assets removed from a plan. Of course, it should show the missed opportunity of assets not in the market.



(Photo credit: 401(K) 2013)



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