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Retirement Savings Plan--It Is My Money

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April 23, 2012

Most employer-sponsored defined contribution retirement plans (401(k), 403(b), 457) include a loan feature even though employers are not required by law to include loans in the plan design. Employer retirement plans that make loans available to plan participants may restrain their use by:

  1. restricting how many loans you can have at one time

  2. limiting the reasons for borrowing (for example, to be the same as those for taking a hardship withdrawalpurchasing a primary residence, paying for unreimbursed medical and higher education expenses, etc.)

  3. establishing a minimum amount that can be borrowed (for example, $1,000)

The Retirement Plan Grand Bargain

As a retirement plan participant, you may balk at these loan restrictions and any other restrictions blocking easy access to the money in your retirement plan. But there are good reasons these restrictions are in place. First and foremost, your retirement plan is intended for retirement. Period. Not to use as an emergency fund or to purchase a vacation home, but to serve as income when you are no longer working. You receive valuable tax incentives when you contribute to an employer-sponsored retirement plan, and in exchange for these tax advantages, you agree to use the money to cover expenses once you retire.

Tax Treatment of Retirement Plan Contributions

Contributions to your traditional defined contribution retirement plan are pre-tax. In other words, the federal government (and most state governments) allows you to elect to transfer a percentage of your income to your retirement account tax-deferred. The federal government has agreed to defer collection of income taxes on this portion of your income as an incentive for you to save for your retirement. The government knows that you will need other retirement savings to supplement Social Security. Social Security retirement benefits will, on average, replace about 40% of your preretirement income.

Retirement Plan Tax Incentives in Jeopardy?

Still think you should be able to access the funds in your retirement account at any time and for any reason? Consider this, in order to entice you to save for retirement, the federal government delays collecting $140 to $200 billion a year in taxes. Would you rather lose these tax retirement saving incentives and have less money to set aside now? A recent study by the Investment Company Institute (ICI), entitled America's Commitment to Retirement Security (Investors Attitudes and Actions) says that you are not.

Two key findings of the survey prove this point:

  • More than 80 percent of defined contribution retirement plan-owning households said the immediate tax savings from their retirement plans were a big incentive to contribute

  • A majority of households disagreed with proposals to remove or reduce tax incentives for retirement savings

The "proposal" refers to a hearing held by the federal House Ways and Means Committee on changing the tax-favored status of retirement plans. As the government wrestles with reducing the deficit, reforming the tax code, and raising revenue, the estimated $140 to $200 billion in deferred retirement plan tax income is getting renewed attention.

Whether Congress will follow up these hearings with legislation that changes the tax-favored status of employer-sponsored retirement plans is anyones guess. However, the next time you think that you can do whatever you want with your 401(k) plan before you retire, remember the primary reason these plans exist. They exist because the government does not want to take care of you in your retirement (other than Social Security retirement benefits). Therefore, it provides tax incentives for you to save for your own retirement. So, it is not your money, yet.

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