Tapping 401(k) Now May Cause Financial Pain Later

With many people struggling to make mortgage payments, some are turning to their retirement accounts to make ends meet.

Two years ago, Ashley Kennedy and her husband, Nathan Makdad, now both in their late 20s, decided to buy a condo in the Boston area. Now they're moving and have to sell at a loss because of the downturn in the real estate market.

"At that point in time, it seemed like the smart thing to do was to not have to pay rent," Makdad recalls. "Everyone kept saying, 'You'll never lose money on a house. It's the safest investment in the world.' Boy, now all I wish we'd done was rent."

That regret will cost them for the rest of their lives. To come up with the money needed to pay off their mortgage, Makdad is cashing out his entire retirement savings — $15,000. There's a big penalty for early withdrawal and taxes. Once he pays those, he'll end up with just over $11,000.

More and more people are following this path.

Fidelity Investments has the largest mutual fund assets in the country, according to the Investment Company Institute, a trade association for U.S. investment companies. Fidelity says these so-called hardship withdrawals are up 16 percent in the first three months of 2008, compared to the same period last year.

So far, less than 1 percent of Fidelity's 13 million retirement-account holders are raiding their 401(k)s, according to the company. But those who tap into their retirement savings could pay a price for years to come.

"It's a terrible choice on so many levels, because we shouldn't be messing with our futures for the present," says Jane King, a financial planner who serves as president of Fairfield Financial Advisors in Wellesley, Mass. For the first time in her career, she's been getting calls about hardship withdrawals. King blames the housing market. She says until now, if anyone had surprise expenses, they'd normally take out a home equity loan.

"People had wiggle room by borrowing on their houses, and it just isn't there anymore," King says. "So the 401(k) or the retirement plan has become maybe the next best thing."

Alicia Munnell, director of the Center for Retirement Research at Boston College, says the real price of cashing out retirement savings early is not the penalty, but the loss of the decades of interest and growth that those savings would have earned.

What irks Munnell is that many of the people taking hardship withdrawals are aware of this.

"The people who join the pension plan in the first place are probably the more prudent, the more careful financial planners," she says. "And so when you see them going and taking their balances out, it really is a bad sign."

Kennedy says she and her husband thought about taking out a loan. "Yes, we are taking about a 25 percent hit on the retirement cash out. But right now it's all about monthly payment. That's just so much more tangible than this amorphous amount of money that's sitting in Nate's retirement account. That's why we're taking that route."

Kennedy and Makdad are scrambling to show their condo to potential buyers. They put out flowers, light scented candles and clear the kitchen counters before buyers arrive.

"We've got to make it look somewhat bigger, somewhat more modern," says Kennedy.

The couple is also selling their condo on their own to save on realtor fees. But there's no way around it — they are going to lose money. And it's money they don't have in the bank.

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