Advisers should help millennials understand hazards of tapping 401(k) savings

Even the lesser evil of taking loans from retirement accounts requires close attention, and often should be a financial solution of last resort

Aug 26, 2016 @ 12:00 pm

By Liz Skinner

Financial advisers with millennial clients should be on alert that the nation's youngest adults are most inclined to tap their retirement savings for other priorities.

About 12% of people ages 18 to 34 have pulled money out of their 401(k) accounts to buy their first home, according to a Scarborough Capital Management survey of adults who have 401(k) accounts. For those 35 to 44, about 7.7% have done so. The percentage decreases further for older adults.

Paying for college is another area where millennials are more likely to consider using retirement funds. Nearly half of millennials said they were considering using 401(k) assets to pay for their children's college costs, compared to 26% of those ages 35 to 44, the survey of 1,004 Americans taken earlier this year found.

(More: DOL issues final rule to help states establish workplace retirement savings programs)

The results suggest advisers need to be tougher with younger clients when explaining to them that the funds could be subject to taxes and other penalties. Additionally, money taken out of 401(k) plans — even as loans — tends not to be replenished, and holders miss out on potential investment gains of those funds.

“There will always be another house, or deal, or opportunity,” said Joshua Goldsmith, a financial adviser with Scarborough. “You only get one shot to save and build your retirement.”

Some younger people say they want the pleasure of buying a home now as opposed to saving for a distant future period, he said. Others say they feel like they can replenish those funds before they'll need them in retirement.

Advisers nearly universally tell clients of every age that withdrawals from their retirement assets should be a financial solution of last resort.

“We always urge clients to do everything in their power to not disrupt the tax-deferred and compound interest of the 401(k),” said Brad Sherman, president of Sherman Wealth Management.

If there is a real need for money, taking out a loan from one's 401(k) can be better than more expensive forms of financing. But 401(k) loan terms must be examined very closely, Mr. Sherman said. That includes the interest rates of the loan, the time frame employees are required to pay themselves back and anything that would impact matching funds from their employer.

Under most plans, dollars that are not repaid by the required time are generally treated like a taxable distribution. Also, if the borrower leaves their employer they typically are required to pay back the entire loan quickly, usually within 60 days.

“You need to have the determination and a plan to pay it back,” Mr. Sherman said. “Advisers should map out the cash flow situation with clients to show them how they'll have to pay the loan back.”

(More: A blueprint to encourage more 401(k) savings )

Interestingly, most people who have invested retirement assets in their first home don't regret that decision.

Of Americans who dipped into their 401(k)s to buy their first home, 61% would do it again, according to the survey.

The biggest issue with tapping 401(k) funds can be that it's hard to stop.

“People are wired to think about 'now' more than they are about the future,” Mr. Goldsmith said. “People constantly think, 'I can make that back later.' But the likelihood of doing so may be slim.”

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