For those of you who are not avid readers of the Detroit News, there was a really well done opinion piece on a new proposal put forward by U.S. Sen. Johnny Isakson, R-Ga., and U.S. Rep. Tom Graves, R-Ga. The writer for the Detroit News, Brian O’Connor succinctly lays out the proposal as follows:
Right now, if you’re strapped you can take a loan against your 401(k) through your workplace. You have to pay it back within five years with interest, but you’re paying it to yourself. About 85 percent of plans offer loans.
If you’re desperate, 89 percent of plans offer hardship withdrawals. Even though you don’t have to pay the money back, it’s a pretty bad deal: You have to pay income tax on the amount withdrawn and a 10 percent penalty if you’re younger than 59-1/2. For most people, it means at least 25 percent of the money withdrawn goes to penalties and taxes, not to saving a home from the bank.
But here’s where the plan backed by Isakson and Graves fails to the point of uselessness: It allows for outright withdrawals, not loans, but it only waives the 10 percent penalty — you’re still on the hook for taxes, ranging from 15 percent on up to the top bracket of 35 percent.
The plan also limits your withdrawal to a maximum of $50,000 or half of your account balance. So, if you withdrew $50,000 and were in the 25 percent tax bracket, you’d skip a $5,000 penalty but still pay $12,500 in federal tax, plus your state income tax. And unlike taking out a loan, all that money would be due April 15, and it would all go to the tax collector.
O’Connor goes on to point out that 401(k) funds are protected in bankruptcy, which is a point I want to highlight. Why? Because if you decide to declare a personal bankruptcy as a way to restart your economic life (which probably means you will lose your home), at least you can hold on to that nest egg in your retirement fund. That can’t be tapped in bankruptcy to satisfy your creditors.
I’ve already written in a prior blog about my experiences of foreclosure prevention in NYC: most homeowners are all too willing to run up their credit cards, poach the kid’s college savings fund, dip into their 401(k) and borrow from Aunt Tilly before they give up the home. This frequently leaves homeowners in a very precarious financial position, and (even worse) frequently does very little to address the underlying economic difficulties in their lives (usually loss of income). I think it’s just plain bad policy to provide further encouragement to distressed homeowners to act so clearly against their own self interests – especially when lenders and servicers have failed to similarly extend themselves and meet distressed homeowners halfway with timely, accurate and equitable workout solutions.
Personal as Political
And here’s what really kills me about this proposal: this solution essentially advocates that homeowners (AKA taxpayers, AKA workers, AKA consumers, AKA citizens) again make a substantial and unprecedented personal sacrifice in an effort to pay back a lender (AKA bank, AKA institution, AKA federal bailout recipient) for a home that is distressed, when that same lender (and the bank that controls it) have frequently failed to provide adequate servicing and support to the homeowner. This presumed “systemic” response (which as O’Connor notes would really provide very little value over a traditional early 401(k) withdrawal for most people) again puts the burden of attempting to resolve the foreclosure crisis on distressed individuals, and apparently does nothing to address either the problematic history of the mortgage bubble (and all the very messy ways that home mortgages were improperly extended, packaged and securitized), nor the myriad current problems within the mortgage servicing industry (such as problematic denials, improper foreclosure proceedings, and the lack of an effective appeals process).
It just really gets my Irish up. And I can’t help but point out that the maximum 401(k) withdrawal amount of $50,000 is the exact same amount that many distressed homeowners should have qualified for under the recent Emergency Homeowners’ Loan Program. In other words, the federal program which suffered from such enormous administrative ponderousness that it only disbursed $432 million of the $1 billion allocated for distressed homeowners should now be replaced by a meager incentive to allow those same distressed homeowners to sack their own retirement savings funds.
That is not really what I would call an effective systemic solution.
For now, let’s hope that the proposal by Isakson and Graves gets all the attention it rightfully deserves. We can do better.