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Tapping your 401(k) © Corbis

Extra3/7/2008 12:01 AM ET

Workers step up raids on 401(k)s

More Americans are tapping their retirement plans as the credit crunch and falling home values make cash harder to come by. But such a loan is usually a bad idea.

By The Wall Street Journal

Financially stretched workers are increasingly breaking into their retirement accounts to get cash.

Over the past couple of decades, the 401(k) account and its brethren have become the main retirement savings vehicles for millions of Americans. But as the credit crunch and declining home values limit many types of consumer loans, a growing number of workers are tapping into these accounts as if they were piggy banks.

Eighteen percent of workers had loans outstanding from their retirement plans in 2007, up from 11% in 2006, according to a survey by the Transamerica Center for Retirement Studies, a nonprofit corporation funded by Transamerica Life Insurance.

Major retirement plan providers are reporting a similar trend. The number of participants taking loans from their 401(k) plans rose by 7% at the end of last year from six months earlier, according to a JPMorgan Chase analysis of 350 plans nationwide that cover 1.3 million people. Those results followed a period from January 2005 through June 2007 when loans from these 401(k) plans fell by 15%.

Similarly, in 2007, 401(k) plans administered by Fidelity Investments and T. Rowe Price Group posted increases in loans and so-called hardship withdrawals for people who demonstrated immediate financial needs, such as medical expenses, over the prior year.

In all, there was roughly $49 billion of 401(k) loans outstanding at the end of 2006, according to an estimate by the Employee Benefit Research Institute, a nonprofit research group in Washington, D.C.

Trend is 'alarming'

For workers, a retirement plan loan may seem like a quick and easy solution to a cash crunch. Borrowers don't need good credit ratings, interest rates are generally relatively low, and interest is paid to the borrowers' accounts, not to banks.

But the rise in retirement plan loans is "an alarming trend," says Catherine Collinson, the president of the Transamerica Center for Retirement Studies. "The real secret of building a retirement nest egg is saving over the long term on a consistent basis," she says. Hitting up your retirement account for cash throws a wrench into this process.

There are other reasons why borrowing from your 401(k) can wreak havoc on your finances. A worker who leaves a job before a loan is paid off will have to pay the remaining balance in full or else face taxes and potential penalties. What's more, given the stock market's recent declines, participants now borrowing from plans may be selling assets at depressed values to fund the withdrawals.

Link to foreclosures seen

Why the surge in 401(k) loans? Until recently, soaring home prices made it easy for consumers to tap their home equity for funds. But now that home prices are dropping rapidly in many markets, more workers, loaded with debt and struggling to make mortgage payments, are turning to their retirement plans.

In the Transamerica study, which surveyed more than 2,000 full-time employees at for-profit companies, 49% of those who borrowed from their retirement savings said they had taken the loans to pay off debts, up from 27% in 2006.

In some instances, workers in fear of home foreclosure may be tapping retirement funds as a last-ditch measure, says Anne Lester, a senior portfolio manager at JPMorgan Asset Management.

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"We found a strong correlation between parts of the country where foreclosure rates were high and there was a rise in 401(k) loans or hardship withdrawals," she says.

In the nation's South Atlantic, Midwest and Southwest regions -- areas that have seen the highest increases in foreclosure rates -- more than half of company 401(k) plans have experienced increases in loans and withdrawals since 2006.

Continued: Many don't understand the consequences

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