Resist the temptation. Fight the urge. Fight for your future.
Recently, you may have heard about a spike in 401(k) withdrawals. The evidence is not merely anecdotal. Fidelity Investments recently issued its 2010 overview of the 401(k) accounts it administers and found that 22% of participants had outstanding loans from these retirement savings plans, with the average loan at $8,650. In 2Q 2010, a record 62,000 of Fidelity’s 401(k) participants had taken hardship withdrawals – a jump from 45,000 in the preceding quarter.
If at all possible, you should avoid joining their ranks.
The persuasive argument against a 401(k) loan. If you borrow from your 401(k), you are opening the door to some big risks (perhaps not immediately evident to you) and you may pay some severe opportunity costs.
• What if you lose your job? That’s an all-too-common occurrence right now. If you get laid off or leave your job and you have an outstanding 401(k) loan, guess what – you usually have just 60 days to pay it all back, 60 days without income from work. Well, what if you don’t pay it all back? The outstanding loan balance may be recharacterized as a 401(k) withdrawal. If you are younger than 59½, you may be assessed a 10% federal tax penalty on the “withdrawal amount”, which by the way would be taxed as ordinary income.
• What will you do with the money? Will it be invested in anything? If not, it won’t grow. When you take a 401(k) loan and use the money for an expense, you are forfeiting its potential for growth and compounding. (Think: how much could that lump sum grow over 20 or 30 years if your account returns 5% or 8% a year? Do the math, look at the potential.)
• The terms of a 401(k) loan are less than ideal. You can’t deduct interest on a 401(k) loan, and that interest is typically one or two points above the prime rate. Here’s another thing few people realize about 401(k) loans: when you pay the money back, you pay it back with after-tax dollars. Ultimately, those dollars will be taxed again when you take a 401(k) distribution someday.
The compelling case against hardship withdrawals. Sometimes these are made in worst-case scenarios – someone is being evicted or foreclosed on, or needs money to pay medical bills. Sometimes people think hardship withdrawals are “good debt” – they make these withdrawals in order to pay college costs or buy a house. Well, here are the reasons that you might want to look elsewhere for the money.
• You may not be able to get a hardship withdrawal. Some 401(k) plans don’t allow them. Many do, but you will have to satisfy some IRS rules. Hardship withdrawals can only be made to pay medical expenses that are more than 7.5% of your adjusted gross income, to pay qualified tuition expenses, to pay funeral/burial costs, to buy a home, to make home repairs, or to stop eviction or foreclosure on a primary residence. Beyond those IRS requirements, the company you work for might have its own stipulations. Some firms won’t give an employee a hardship withdrawal unless the employee can demonstrate that no other source can provide the needed funds.
• You may not be able to withdraw as much as you want. Okay, let’s say you are able to take a hardship withdrawal. The money is considered a retirement plan distribution. By law, your employer has to withhold 20% of it because you aren’t making a trustee-to-trustee transfer with the funds. Are you younger than 59½? If so, you may be hit with an additional 10% tax penalty for early withdrawal. Regardless of your age, the amount you withdraw will be taxed as ordinary income. So besides the potential subtractions above, you’ll lose even more of the lump sum you pull out to income taxes. Only in very rare cases can you get a hardship withdrawal without penalty (court order, total disability). Even in those circumstances, the money is still taxable.
• You can’t pay the money back. It would be nice if you could, but you can’t. To add insult to injury, after you reduce your retirement savings through the hardship withdrawal, you typically can’t contribute to your 401(k) for the next six months.
Knowing all this, would you still consider these moves? Is it worth it to possibly do harm to your retirement savings potential? There are alternatives. Talk to a financial services professional – you may be pleasantly surprised to learn what other options might be available.
Monday, September 27, 2010
Monday, September 13, 2010
OBAMA'S MIDTERM TAX PROPOSALS
The President recommends what amounts to a second stimulus package.
Many Americans are frustrated with the pace of the economic recovery; many Democrats are worried that their party will lose its majority in the House and Senate. As elections loom, President Obama has offered a new platform of tax initiatives for Congress to consider and potentially approve.
Extending the Bush-era tax cuts (for the middle class). President Obama wants to extend the EGTRRA and JGTRRA cuts of the last decade – but not to what Treasury Secretary Timothy Geithner referred to as the “most fortunate 2% of Americans.” Taxpayers who earn more than $250,000 would see those tax breaks disappear in 2011, while others would still benefit from them.
Why not extend the Bush-era tax breaks for the demographic that is probably the most economically influential? “We don’t think that’s responsible economic policy,” Geithner commented during an interview on the FOX Business Network. He felt that preserving the cuts for the highest-earning Americans would be analogous to “borrowing hundreds of billions of dollars from our children.”
Some contend that EGTRRA and JGTRRA have had broader impact. The Tax Foundation (a non-partisan Washington D.C. think tank which often criticizes tax policy) claims that the Bush-era tax cuts have saved the median U.S. family of four about $2,200 per year.
However, an August Gallup poll indicated that only 37% of Americans wanted to keep the 2001 and 2003 tax cuts in place for all taxpayers. A plurality (44%) wanted to end them for those earning above $250,000, and 15% wanted them gone altogether. In partisan terms, 60% of the Democrats polled favored extending the cuts for all but the wealthiest Americans; 54% of Republicans polled wanted them retained for everyone.
Offering tax breaks for capital spending and R&D. President Obama wants to allow businesses to write off 100% of their investment costs through 2011. He also wants to bring back the research tax credit for businesses – it would be expanded and made permanent.
What would a 100% expensing credit do for the business sector? On the right, Harvard economist Greg Mankiw calls it a “good idea” yet feels “the impact will be relatively modest.” In his view, this tax break amounts to “a zero-interest loan if [companies] invest in equipment. But with interest rates near zero anyway, the value of the loan is not that great.” On the left, UC Berkeley economist (and former Labor Secretary) Robert Reich thinks that “the economy needs two whopping corporate tax cuts right now as much as someone with a serious heart condition needs Botox. The reason businesses aren’t investing in new plant and equipment has nothing to do with the cost of capital. It’s because they don’t need the additional capacity.”
Historically, the R&D tax credit has favored larger companies with long track records in research rather than smaller firms. Since 1981, Congress has allowed the R&D credit to sunset 13 times – it expired again at the end of last year. In the Obama proposal, the most popular R&D tax credit offered to businesses would rise to 17% from 14%. Many Silicon Valley firms and biomedical firms would love any break they can get – R&D credits in India, China and Brazil are all greater than in the U.S., and France's R&D tax credit is six times more generous than ours.
Infrastructure projects to provide added stimulus. The President also wants to devote another $50 billion to infrastructure spending on roads, railroads and airports. The money would be used to repair 150,000 miles of highways and 4,000 miles of railways, among other uses. Some transportation industry analysts see it as merely a drop in the bucket – but also possibly a step toward the creation of a national infrastructural fund.
What might the effect be? Moody’s Analytics chief economist Mark Zandi thinks the proposed tax breaks would be “helpful but they're not going to jump start the economy, at least not in the next six to twelve months.” Interviewed by CNN, Zandi noted that “Investment spending has picked up very nicely, that's not the problem. The problem is a lack of hiring.”
David Rosenberg, chief economist at investment bank Gluskin Sheff, is one voice more skeptical about the business tax breaks. He notes that “We already have business spending running at its fastest rate in three decades … how ridiculous is it for the government to be targeting tax relief to the one part of the economy that needs it the least?”
Standard & Poor’s chief economist David Wyss feels that any new government stimulus is better than none, saying that “going cold turkey” in 2010 would severely damage growth. The debate on Capitol Hill over these tax initiatives will likely amplify as we head into fall.
Many Americans are frustrated with the pace of the economic recovery; many Democrats are worried that their party will lose its majority in the House and Senate. As elections loom, President Obama has offered a new platform of tax initiatives for Congress to consider and potentially approve.
Extending the Bush-era tax cuts (for the middle class). President Obama wants to extend the EGTRRA and JGTRRA cuts of the last decade – but not to what Treasury Secretary Timothy Geithner referred to as the “most fortunate 2% of Americans.” Taxpayers who earn more than $250,000 would see those tax breaks disappear in 2011, while others would still benefit from them.
Why not extend the Bush-era tax breaks for the demographic that is probably the most economically influential? “We don’t think that’s responsible economic policy,” Geithner commented during an interview on the FOX Business Network. He felt that preserving the cuts for the highest-earning Americans would be analogous to “borrowing hundreds of billions of dollars from our children.”
Some contend that EGTRRA and JGTRRA have had broader impact. The Tax Foundation (a non-partisan Washington D.C. think tank which often criticizes tax policy) claims that the Bush-era tax cuts have saved the median U.S. family of four about $2,200 per year.
However, an August Gallup poll indicated that only 37% of Americans wanted to keep the 2001 and 2003 tax cuts in place for all taxpayers. A plurality (44%) wanted to end them for those earning above $250,000, and 15% wanted them gone altogether. In partisan terms, 60% of the Democrats polled favored extending the cuts for all but the wealthiest Americans; 54% of Republicans polled wanted them retained for everyone.
Offering tax breaks for capital spending and R&D. President Obama wants to allow businesses to write off 100% of their investment costs through 2011. He also wants to bring back the research tax credit for businesses – it would be expanded and made permanent.
What would a 100% expensing credit do for the business sector? On the right, Harvard economist Greg Mankiw calls it a “good idea” yet feels “the impact will be relatively modest.” In his view, this tax break amounts to “a zero-interest loan if [companies] invest in equipment. But with interest rates near zero anyway, the value of the loan is not that great.” On the left, UC Berkeley economist (and former Labor Secretary) Robert Reich thinks that “the economy needs two whopping corporate tax cuts right now as much as someone with a serious heart condition needs Botox. The reason businesses aren’t investing in new plant and equipment has nothing to do with the cost of capital. It’s because they don’t need the additional capacity.”
Historically, the R&D tax credit has favored larger companies with long track records in research rather than smaller firms. Since 1981, Congress has allowed the R&D credit to sunset 13 times – it expired again at the end of last year. In the Obama proposal, the most popular R&D tax credit offered to businesses would rise to 17% from 14%. Many Silicon Valley firms and biomedical firms would love any break they can get – R&D credits in India, China and Brazil are all greater than in the U.S., and France's R&D tax credit is six times more generous than ours.
Infrastructure projects to provide added stimulus. The President also wants to devote another $50 billion to infrastructure spending on roads, railroads and airports. The money would be used to repair 150,000 miles of highways and 4,000 miles of railways, among other uses. Some transportation industry analysts see it as merely a drop in the bucket – but also possibly a step toward the creation of a national infrastructural fund.
What might the effect be? Moody’s Analytics chief economist Mark Zandi thinks the proposed tax breaks would be “helpful but they're not going to jump start the economy, at least not in the next six to twelve months.” Interviewed by CNN, Zandi noted that “Investment spending has picked up very nicely, that's not the problem. The problem is a lack of hiring.”
David Rosenberg, chief economist at investment bank Gluskin Sheff, is one voice more skeptical about the business tax breaks. He notes that “We already have business spending running at its fastest rate in three decades … how ridiculous is it for the government to be targeting tax relief to the one part of the economy that needs it the least?”
Standard & Poor’s chief economist David Wyss feels that any new government stimulus is better than none, saying that “going cold turkey” in 2010 would severely damage growth. The debate on Capitol Hill over these tax initiatives will likely amplify as we head into fall.
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