Cecily O'Connor
RedwoodAge.com

Financial planners have long cautioned against using 401(k) savings plans like ATM machines. But in the current economy some boomers have few savings options if they want to keep their house or send a kid to college. 

As a result, a growing number of people in what should be their peak earning years are borrowing against their 401(k) assets or making "hardship withdrawals," according to a research report from Fidelity Investments. The number of loans started over the past 12 months grew to 11 percent of total active participants, up from about 9 percent a year ago. The average initial loan amount was $8,650 at the end of the second quarter, with an average duration of three and half years.

In addition, about 62,000 401(k) participants initiated a hardship withdrawal in the second quarter, up from 45,000 participants the prior quarter.  

James MacDonald, Fidelity's president of workplace investing, said "...the current economy has forced some workers to borrow from their 401(k) accounts in order to pay for critical living expenses, ultimately jeopardizing their future retirement."

The trend comes at a time when other investors are moving away from stocks and into the relative safety of bonds, despite historically low yields on fixed investments. According to the Investment Company Institute, which tracks the mutual fund industry, $35 billion was withdrawn from stock funds in the first half of 2010 while $170 billion was added to bond funds.

'Only Form of Savings'
The average age of those taking a loan or hardship withdrawal is between 35 and 55 years old – a worker’s peak earning years. They are tapping their 401(k) accounts are to prevent foreclosure or eviction, pay for college, and the purchase of a primary residence, according to Fidelity.

The average 401(k) account balance at end of the second quarter was $61,800, up 15 percent from the same time last year, but down from the end of the first quarter of 2010.

“We recognize that for some, taking a loan or a hardship withdrawal from their 401(k) may be their only option because it’s their only form of savings,” MacDonald said. “However, we want to make sure that before workers tap their retirement accounts prematurely, they are fully educated about both the penalty that may be incurred and the long-term implications for their retirement.”

If your 401(k) plan allows loans, you can borrow up to 50 percent of the vested account balance or $50,000 - whichever is less. Certain financial emergencies could leave boomers with few options to generate cash. However, the decision shouldn't be made lightly since there are many financial repercussions.

For example, taking out a loan from a 401(k) can upset the dollar cost averaging process, making it very difficult to fully recoup the borrowed asset over time. Not to mention the potential for losing some hard-earned savings to penalties. Distributions from a 401(k) or 403(b) are taxed as ordinary income, while boomers under age 59½ may be subject to a 10 percent early withdrawal penalty.

When in doubt, it's smart to weigh the pros and cons with a financial planner.