Proposed Law Would Make Raiding Retirement Less Taxing

Posted at 5:34 PM, Apr 04, 2013
and last updated 2013-06-07 12:01:47-04

Tapping retirement money early has become a trend in recent years.

According to the financial advisory firm HelloWallet, 26 percent of American workers with 401(k)s have used account funds to pay for current expenses. Workers in the U.S. now withdraw or breach more than $70 billion annually out of their 401(k) s for non-retirement needs.

Employees who raid their retirement accounts early and proceed to leave their workplace soon after could face stiff bills from the IRS. Under current law, employees have 60 days to repay any loans or withdrawals following their separation from their employers to avoid tax penalties.

Few workers who take out retirement funds are able to meet this deadline.

“Sixty days slip by fast when people are dealing with a job change, particularly one involving relocation,” says Greg McBride, CFA, and Senior Financial Analyst for “Factor in a gap in paychecks when switching jobs, and it is increasingly unlikely that employees can repay an outstanding 401k loan within the 60-day timeframe.”

According to a 2011 study by consulting firm Aon Hewitt, nearly 70 percent of employees default on outstanding retirement account loans after leaving a job.

It’s a sign of the times that federal legislation has been put forth to allow workers extra time to settle up their account balances after leaving a job to avoid extra fees. The bill has bipartisan support in the U.S. Senate.

The Shrinking Emergency Account Losses Act, or SEAL Act, sponsored by Sens. Bill Nelson (D-FL) and Mike Enzi (R-WY), would give workers who leave their jobs up until the time they file their federal taxes to repay money they’ve taken out of their company’s retirement plan.

“We need to give folks more incentives to continue saving for their retirement,” said Nelson in a press release. “Giving them extra time to restore money owed to their 401(k)s is one way we can help cut down on lost retirement savings.”

McBride says this deadline extension would increase the likelihood of repayment and would preserve the 401(k) balance as an intended retirement nest egg.

The bill would also allow employees to continue to contribute to their 401(k)s during the six months following a hardship withdrawal, a practice currently prohibited. Letting workers fund their accounts after a withdrawal would enable them to receive a company’s matching contributions.

This portion of the bill draws some dissent among experts in the financial industry.

The intent of the proposed law is to give workers the option to bail themselves out using their own retirement savings, while providing them the opportunity to immediately begin replenishing their retirement account after the withdrawal.

But in practice, this provision could backfire if too many workers put their financial future at risk to meet today’s needs. Certain barriers in the existing law encourage employees to find other ways to make ends meet without touching their retirement savings.

“While a good idea in theory because it allows additional contributions toward retirement and capturing of an employer match, the unintended consequence is that it could lead to an increase in hardship withdrawals without the deterrent of being locked out of contributing for six months,” says McBride.

Brian Graff, CEO of the American Society of Pension Professionals and Actuaries, or ASPAA, said in a recent statement, “We are mindful that some employees have serious immediate financial needs. Therefore, we believe it is important to minimize the harm that comes from accessing retirement funds for non retirement purposes.”

Though a similar version of the bill didn’t make it onto the books last year, it appears this latest version is garnering support and gaining steam.