By Nick Carey - Analysis
CHICAGO (Reuters) - Trapped by rising mortgage payments and falling house values, a growing number of squeezed middle-class homeowners are tapping into their treasured retirement nest eggs to ward off foreclosure.
“This is definitely an issue we’ve been hearing about from our members,” said Kevin Stein, associate director of the California Reinvestment Coalition, which represents 250 nonprofit groups and public agencies in the state.
“It does seem the crisis is impacting a broader segment of America, and it clearly calls for broader solutions than what we have so far,” Stein said.
Apart from being a fresh sign that the housing crisis has spread up the U.S. income ladder, tapping tax-deferred savings accounts like 401(k) plans could have profound effects on taxpayer welfare, social security and employment patterns, economists and financial advisers said.
“I think this means we’ll see some baby boomers having to work well into their 70s to make ends meet,” University of Maryland economist Peter Morici said.
Before 1980, most U.S. workers relied on so-called defined benefit or “pension” plans managed by their employers. Those were meant to supplement government Social Security payments, which first become available to workers at age 62.
But pensions have been gradually replaced by 401(k)s, or defined contribution plans that let employees decide how much they want to contribute. They can also withdraw funds, as this encourages younger workers to contribute, experts said.
According to a March 2007 survey, the U.S. Bureau of Labor Statistics found that 55 percent of U.S. workers had access to defined contribution plans and 43 percent were participating.
In 2006, Americans had more than $2.7 trillion invested in 401(k)s, according to the Investment Company Institute. Assets in the plans rose an average 13 percent a year since 1990.
But faced, for instance, with spiking payments on their adjustable rate mortgages in 2007 and 2008, a growing number of people are apparently using the 401(k) withdrawal option.
“Home ownership is a deep, emotional part of the American dream,” said Linda McGonagle, a realtor in Livonia, Michigan. “Some people will do anything to hold on to that dream.”
“We’ve had a few people coming through our foreclosure prevention class looking to use their 401(k)s to stay current,” said Tim Bolding, executive director of nonprofit lender United Housing in Memphis, Tennessee. “We’re talking doctors, lawyers and other professionals.”
“The misnomer is that the housing crisis is restricted to poor borrowers,” he added. “But it has gone so much further.”
Great-West Retirement Services, which manages more than $115 billion in assets, reported a 20 percent increase in the number of people citing “avoiding evictions or foreclosure” as the reason for emergency 401(k) withdrawals in January 2008, compared with January 2007.
“The crisis is still relatively new so we don’t have hard data yet, but anecdotal evidence suggests more people are interrupting participation or withdrawing funds from their 401(k)s,” said David Wray, president of the ProfitSharing/401k Council of America (PSCA), a nationwide association of 1,200 companies with 6 million employees in 401(k) plans.
“This appears to be concentrated in parts of the country where the housing problem is deeper,” Wray said.
Experts said the depth of homeowner stress is seen not just in tapping retirement funds but paying big fees and penalties.
Julie Jason, president of Stamford, Connecticut-based Jackson, Grant Investment Advisers, said borrowing from a 401(k) is risky because if you lose your job and default on payments, you end paying both taxes and penalties. “It’s even riskier given the job market right now,” she said.
Most 401(k) fund withdrawals carry a minimum 10 percent penalty fee and are subject to immediate income taxes. If you borrow from your 401(k) and default on the loan, then the same penalty fee and tax liability apply.
Jason gave an example of a 45-year-old male who borrows $50,000 from his 401(k), then defaults. Apart from taxes, if he “does a little time travel to age 75 and looks back” he would see he has lost $500,000, assuming an historical 8 percent average 401(k) annual gain. “In short, he loses big time.”
Editing by Peter Bohan and Richard Chang