Robbing Peter to pay Paul: More people borrowing from their 401(k) plans

As residents of Georgia and individuals across the nation continue to struggle with high debt loads and overwhelming monthly bills, a dangerous trend is rearing its ugly head. Employees are not only failing to save as much as they should for retirement, they are actually borrowing from their own retirement savings accounts and further jeopardizing their futures.

Estimates show that a quarter of American workers are currently borrowing money from their own 401(k) plans in order to pay their non-retirement related bills. Defined contribution pension plans - also known as 401(k) plans - are employer-sponsored retirement savings accounts and employees can contribute money to the accounts on a tax-free basis. After as employee retires, the funds are available for use and are taxed at the employee's post-retirement tax rate, which is typically lower than when he or she was working.

While some may view their retirement savings as easily accessible funds during times of need, borrowing from those types of account can hurt them in the long run. Filing for bankruptcy may be a far better option than taking a loan on 401(k) funds.

Dangers of borrowing from a 401(k)

As with any loan, there are costs associated with borrowing from one's 401(k). The money borrowed is repaid with interest, as one would expect, but that is not all. Funds borrowed are tax-free but the loan is repaid with money that has already been taxed and, when withdrawn after retirement, those funds are taxed again.

Additionally, the payback period for 401(k) loans is typically 30 to 90 days and, if the loan is not promptly repaid, or the borrower loses his or her job before repayment is complete, the borrower must:

  • Immediately repay the entire amount
  • Pay a 10 percent withdrawal penalty
  • Pay income tax on the borrowed amount at the borrower's current tax rate

Furthermore, when people are repaying such loans, they typically stop funding their 401(k) plans, putting them even further behind on their retirement savings.

Essentially, borrowing from your 401(k) is like robbing your future self. There are other options available, however.

Financial assistance through bankruptcy

Filing for bankruptcy can be a much better option for most individuals who suffer from overwhelming debt. Bankruptcy helps millions of people attain freedom from creditor harassment, wage garnishment, home foreclosure and financial ruin.

Filing for Chapter 7 bankruptcy may wipe the slate clean of most, if not all, of an individual's unsecure debts. Chapter 13 bankruptcy allows a person to restructure his or her debt load, consolidating payments into a manageable amount each month.

For those who are already retired, bankruptcy can protect your retirement income by wiping out medical and credit card debts.

If you are considering tapping into your retirement savings to help pay your current bills, consult with an experienced bankruptcy attorney to find out what options may be available to you.