More people dipping into their 401(k)s

The days of using your house as a piggy bank are over, and it’s harder to get a consumer loan these days. So where are Americans turning to finance college, buy cars and get credit card companies off of their backs? Their 401(k) plans.

As of June 30, 21.9 percent of workers with 401(k) plans had loans outstanding, up from 19.3 percent in 2008, according to Fidelity Investments. The average initial loan amount was $8,650, about where it has hovered for the past decade.

This pattern has played out before. At the start of the 2001 recession, 18.4 percent of active participants had a loan. By June of 2004, that number had risen to 21.1 percent. Many don’t have an alternative.

“The economy (is) forcing some people to find additional money to cover their living expenses,” Beth McHugh, Fidelity’s vice president of market insights, explained.

In general, financial advisers consider 401(k) loans a last resort. They recommend first turning to emergency savings and taxable accounts for fast cash. Problem is, the financial services industry has put such an emphasis on saving for retirement that short-term savings has been given short shrift.

Ross Dahlof, whose business is helping employers design 401(k) plans and advising participants, tries to get a sense of why the client is considering a loan.

“Are you really solving a problem by taking a loan to pay off credit card debt? There’s probably a bigger problem and that’s probably spending,” said Scot Hanson, a certified financial planner, has seen loans work out for clients, like the time someone needed a bridge loan for a down payment on another house.

But he’s also seen people use retirement funds to go on vacation, buy a snowmobile or juggle vehicle payments.

Here’s another potential trap: When someone with a 401(k) loan loses a job (and is under the retirement money-tapping age of 59 ½) the loan must be paid back in a matter of months. Otherwise it’s considered a distribution and could be subject to taxes and penalties. If you needed the loan in the first place, my guess is you wouldn’t be able to pay it back in a squeeze.

Then there’s the risk of falling short of your retirement goal. “You would miss out on that extra compounding you were getting on that money you took out,” said Mary Guillaume, a wealth adviser for UBS Financial Services. Of course, that’s presuming that the market is going up.