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How you handle your 401(k) savings depends a lot on how much you earn.
And if you're middle income — earning between $40,000 and $85,000 — you're more likely to take a loan from your 401(k) or other workplace retirement plan, according to new research from J.P. Morgan Asset Management.
Individuals who fall in that category are 50 percent more likely to take a loan compared to those who are low income, earning below $40,000, and those who are high income, who take in more than $85,000.
The research concluded that that may be because low-income earners are less engaged with their retirement plans, while high-income workers are less likely to need that money.
The tendency for middle-income workers to borrow can be a sign of financial stress, said Anne Lester, portfolio manager and global head of retirement solutions at J.P. Morgan Asset Management.
"Even as much as $200,000 in annual income, many of those households earning that level are really living pay check to pay check," Lester said.
Many of those middle-income workers have significant balances in their retirement plans, she said. And they don't have the financial stability elsewhere — such as an emergency savings account — that would let them avoid tapping those funds.
"Life happens, and you need the money," Lester said.
Of note, J.P. Morgan's research found that workers are still below the 10 percent or more target savings rate for their retirement plans.
Contribution rates by salary level
Source: J.P. Morgan Asset Management
The options to take withdrawals from retirement plans often confuses plan participants.
In fact, understanding withdrawal options came up as one of the top issues that mystify retirement account holders, according to a recent study released by startup Dream Forward.
Financial professionals caution that just because you can take money out of your 401(k), that doesn't mean you should.
The reasons people tap their retirement funds can range from covering immediate cash needs to funding a down payment on a home.
"I find that most people who have 401(k) loans tend to have cash-flow issues," said Cathy Curtis, founder and chief executive officer of Curtis Financial Planning.
Those issues can include either overspending or under-earning, she said. And there are often other symptoms, such as credit card debt, that can indicate poor financial habits.
Individuals considering taking a loan from their retirement plan need to think about the consequences.
You can usually borrow up to 50 percent of your account balance, or up to $50,000, according to federal law. You then have up to five years to pay back the loan.
The loans must be paid back plus interest. In the meantime, you sacrifice the gains your investments could have been making if you had left it in your account.
"You're basically robbing yourself of future money by taking a loan," said Aaron Pottichen, senior vice president at Alliant Retirement Consulting.
The other issue is if you leave your employer or lose your job, you will be required to pay that money back sooner. In that case, you now have until you file your taxes to pay off the loan. Prior to this year, the rule was 60 days.
When educating employees about their retirement plans, Pottichen said he emphasizes one key point: Try and focus on avoiding loans from your retirement plan if at all possible.
Instead, you should have an emergency fund of three to six months' worth of earnings in cash, he said. And if you don't, you should stop contributing to your retirement plan until you have built up that fund.
It also helps to identify your short-, medium- and long-term goals. If you want to buy a home in five years, planning for that down payment ahead of time can help avoid the need to take loans from your retirement plan, Pottichen said.
One strategy Curtis said she sometimes advocates for her clients: Funding their 401(k) plan up to the employer match, and then allocating the rest of the money to a Roth IRA account.
With Roth accounts, you have more flexibility to withdraw the funds you've invested without having to take out loans and pay interest.
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And if you absolutely must take a loan, it may be more advantageous to secure those funds from elsewhere, Curtis said.
A home equity line, if someone owns a home, can be a better option, she said. That is because you keep your retirement money invested. And the interest rates on home equity loans may be more competitive, though they are going up.
To understand what's truly best for you, it's best to meet with a fiduciary advisor who can help you sort through your options, Pottichen said.
J.P. Morgan's research analyzed saving and spending behaviors of more than 4,000 defined contribution plans with about 2 million participants.