W Post: U.S. Should Offer Tax Relief to People Who Turned to Their 401(k) for a Bailout

[Omaha Steve]

http://www.washingtonpost.com/wp-dyn/content/article/2009/08/12/AR2009081202968.html

By Michelle Singletary
Thursday, August 13, 2009

As the Obama administration continues to look for ways to ease the financial pain that people are feeling in this recession, I hope it will provide relief for the many folks who are facing huge tax bills because of 401(k) loans.

For some, a 401(k) loan can be an appropriate bailout during difficult times. After all, you're borrowing your own money from your retirement plan and paying it back in monthly installments over five years, unless the loan is used to buy a primary residence. Plus you are paying interest to yourself -- typically the prime rate or prime plus one percentage point.

But if you leave your job, either voluntarily or through a layoff, the loan becomes due within 90 days. If you default, it will be costly.

First, the loan amount is subject to federal and state income taxes because the loan disbursement is considered taxable income. Remember, when you put money into a 401(k), it is not taxed. On top of the taxes due, if you are younger than 59 1/2 , you have to pay a 10 percent penalty for early withdrawal.

For a laid-off worker with no immediate job prospects, the penalty and pending tax bill can be financially devastating.

With all the temporary measures flying through Congress, it seems logical and compassionate to give a reprieve -- if only temporarily -- to employees who took out 401(k) loans and now can't pay them back.

FULL 2 page story at link.

[M0rpheus]

1. As an employee of an administrator for many of the fortune 500 plans...

I have seen people royally screwed with layoffs. Taking large loans and Hardship withdrawals, and then not having a job the next day. People trying to save their houses or making up shortfalls in rent, to prevent eviction have shot up in the last 12 months. Even after they leave the company, they're taking all their money because they have no choice. They just lost their jobs and they still have bills to pay. I make each one of them aware of the tax hit they're about to take and almost to a person they all say "I have no choice". Even in the middle of the downturn, when people had lost 30-40% of their value in the account, they still took the money, just to get through.

I'd say a tax break would be a good thing. Even if it was just making the mandatory 20% the limit, with no penalty for 2008 and 2009, that would help a lot of the people I've talked to, who can't afford that hit come April.

[Thickasabrick]

2. Actually, it's 55. If you are fired or quit after you turn 55, and

forced to withdraw your 401 instead of keeping it for retirement, you are not subject to the 10% penalty.