Penalty for saving home with 401(k)?

When you're struggling to pay the mortgage, the stash in a 401(k) retirement plan can look pretty enticing. So what became of the ’08 discussion about partially suspending the hefty penalty for early withdrawals of 401(k) money?

Fair question, given the rising wave of mortgage delinquencies and threat of foreclosure.

Short answer: Hasn’t happened.

Where it started: Late in 2008, then President-elect Obama included the penalty easing proposal in an early economic revitalization plan. People would be “facing unique economic hardship,” according to http://change.gov/agenda/economy_agenda/. The plan called for legislation that would waive the penalty on limited withdrawals "to help these families pay their bills and their mortgages and make it through these tough times."

PolitiFact.com, a Pulitzer winning site from the St. Petersburg Times, rated the issue a "Promise Broken" last year. http://www.politifact.com/truth-o-meter/promises/promise/508/allow-penalty-free-hardship-withdrawals-from-retir/

And it popped up again, just last week, when President Obama and Vice President Biden spoke at a town hall meeting in Tampa. A participant noted that tough economic times are forcing many people to make 401(k) withdrawals, and they can’t afford the penalty.

Obama responded that the penalty is in place “because you’re getting that money tax-free, the idea being that you’re going to actually use it for retirement. And then if you’re spending it early, before retirement, then you can imagine that a lot of people could potentially game the system by using these accounts to avoid taxes,” according to a transcript (http://www.whitehouse.gov/the-press-office/remarks-president-and-vice-president-town-hall-meeting-tampa-florida).

However, the President said the point is legitimate. “Blanket amnesties in all circumstances may not be possible,” he said. “But taking a look at certain narrow categories of emergencies in which these penalties could be waived is something that we have discussed and I think we could explore.”

Ed Ferrigno, who heads government relations for the Profit Sharing/401K Council of America, said most years someone in Congress calls for waiving the penalty for some reason. But the idea never gets much mainstream support. The only exception he recalls was for victims of the massively disastrous Hurricane Katrina.

The plans allow people to sock away money before taxes. In exchange for the tax break, you have to leave the money alone until you’re at least 59.5 years old. There are exceptions, including hardship withdrawals. See IRS site http://www.irs.gov/retirement/article/0,,id=162416,00.html for details.

But if you make a withdrawal, you pay regular income taxes and a penalty of 10 percent of the amount withdrawn.

The penalty is a way to “put discipline into the system,” says Ferrigno, whose group represents employers offering the retirement plans. At the same time, allowing withdrawals recognizes that sometimes “the best intentioned people have to re-evaluate their situation.”

Another option is to take a loan against your 401(k), which can be more restrictive but avoids the penalty, as long as it is repaid.

Obama added during the town hall that he has personally experienced the penalty’s pain. He said some years ago, when working in a law firm, the family had emergency needs. He made a retirement plan withdrawal and paid the penalty. “No fun,” he told town hall attendees. “But it was what we had to do.”

He and his wife were young enough to absorb the hit, he said, but acknowledged it would be a greater hardship for a lot of families.

What do you think Save Your Home readers? Should people facing foreclosure get a break on the hardship penalty?

And a request: If you’re struggling with foreclosure, please contact me directly. Call 704-358-5173 or e-mail me at shopkins@charlotteobserver.com. Thanks.