Pamela A. MacLean
RedwoodAge.com

The percentage of workers dipping into their 401(k)s has remained fairly steady, according to a Congressional study. But that doesn't mean boomers are out of the woods as they near retirement.

The report found that 15 percent of participants in company 401(k) retirement plan to pull money out of their retirement nest eggs. This leakage from retirement plans will have the biggest impact on those closest to retirement.

An estimated $108 billion bled from 401(k) plans in 2006 - long before the financial meltdown. The bulk of it came from people who cashed out plans when they left a job rather than rolling over the money into new plan with a new employer.

"We found that cash outs of any amount at job separation - whether taken in part or in full - can have a greater effect on a participant’s account balance at age 65 than comparable amounts taken in the form of a hardship withdrawal or loan," according to the Government Accountability Office study.  And proportionally, the greatest impact is to low wage earners, the report shows.

The main reasons money drains from these accounts are job loss and a failure to roll the money into a new employer's 401(k) plan.  Instead, many people get new jobs and just start again from zero with a new plan.

The rise in unemployment compounds the problem by preventing unemployed participants from making tax-deferred contributions to employer-sponsored plans. In addition, jobless people may need to tap into their retirement nest egg when benefits run out.

Currently the law allows employees and employers to contribute a total of $16,500 per year to an individual 401(k) account. It is up to the individual employee to choose the investment option and set the amount they plan to contribute. 

Half Invest
About half of all US workers participate in some form of an employer-sponsored retirement plan, according to the GAO.  Those who opened 401(k) plans rose from 8 million in the mid-1980s to over 70 million by 2006.  Assets in those plans have gone from $100 billion to over $3 trillion in the same time period, according to the report.

The financial pain doesn't stop with just the failure to restore withdrawn funds. Federal law requires a 10 percent penalty on the amount anyone withdraws early, prior to age 59 1/2, except for death, disability, lose of a job or termination of the plan.  In addition, participants who make early withdrawals are liable for tax on the investment profits withdrawn from the plan.

And threading the rules on withdrawals can be tough.  Each type of withdrawal, whether hardship, a loan or cash out due to job change, has different rules.

Ripple Effects
The report showed the effects of just a $5,000 withdrawal from a 401(k) plan that is not repaid. Someone with a high-paying job who withdraws $5,000 at age 45 would have roughly $42,000 less in their account at age 65. A similar withdrawal at age 55 would mean nearly $30,000 less in the account.  For a 35-year-old who takes out $5,000, the account balance would be roughly $53,000 lower.

But the effect of cashing out an existing account later in a career is particularly damaging because there is no time to recover the losses.

Someone who cashed out a plan at age 35 would have roughly $183,600 less in a second, rebuilt account than if they had left the money alone. And for a boomer cashing out at age 55, there would be 84 percent less in a rebuilt account at age 65.

The report calls for greater education to show participants the importance of preserving retirement savings.  And it urges Congress to consider eliminating a requirement for a six-month suspension of contributions following a hardship withdrawal.