Robbing from the future to pay for the past.

A disturbing trend is emerging as workers begin borrowing from tomorrow’s retirement accounts to pay for today’s lifestyles (Investment News):

With the economy deteriorating and prices for gas and heating fuel skyrocketing, consumers who are seeking new sources of cash are increasingly jeopardizing their retirement income by taking out loans from their retirement plans.

The number of such loans has been growing at double-digit rates, according to top plan providers. [...]

The T. Rowe Price Group Inc. reported that loans from retirement plans it manages were up 10% in each of the past two years, and the trend has continued in 2008, with loans in January and February up 6%, compared with the first two months of 2007. [...]

The Merrill Lynch Retirement Group of Pennington, N.J., reported a similar trend in its proprietary business of 1,500 clients, representing 2.6 million participants and $103 billion in assets.

The firm, a subsidiary of New York-based Merrill Lynch & Co. Inc., said that between the first and fourth quarters of 2007, the number of general-purpose loans from 401(k)s increased 14%, while residential loans decreased 40% and hardship withdrawals jumped 42%.

"We do a lot of education on our website and in statements," said Kevin Crain, managing director for business retirement and corporate market integrated benefits at Merrill Lynch. "They have the right to take out loans, but we want them to think about some of the issues." [...]

Fidelity Investments reported that the number of loans taken by participants in 401(k) plans administered by the Boston-based firm's retirement services division increased in 2007 by just under 4% from 2006, according to company spokesperson Jennifer Engle. Fidelity declined to disclose the number of plans or assets it has under management or the number of participants.

The company also saw a 17% increase in hardship withdrawals between 2006 and 2007. In total, the number of participants making hardship withdrawals is just over 1%, Ms. Engle said.

As Alicia Munnell, director of the Center for Retirement Research at Boston College in Newton, Mass., points out in the article, "If you take out a loan and repay it over five years, the [401(k)] plan suspends your contribution for five years. You'll end up with 82% of what you would have if you left the money there."

Unfortunately, many 401(k) plan particiapnts believe that because their accounts hold their own money, they are doing themselves no harm by self-borrowing. The problem is that no one — including themselves — will lend them money later in retirement if there’s not enough to be had for a comfortable retirement. By borrowing today, they are robbing their accounts of the ability to grow, including years or even decades of the investment power of compound interest.

Asset managers, investment companies, 401(k) platforms, financial advisors, take note: Unless you step to the plate and explain to participants how much harm they are doing, they will continue to cannibalize their own futures to pay for their past mistakes.

What’s needed: a proactive educational program that financial advisors or even plan sponsors can use to to teach plan participants that a 401(k) loan really is a last-resort measure. Don't burglarize your own house — borrow from someone else before you borrow from yourself.

Words to the young and wise

Emily Meehan of the Wall Street Journal spells out "What to Do with $2,500" — a column that gives younger investors clear plans of action from financial wizards, most of whom normally advise only millionaires:

I spoke with five financial advisers about what a young investor should do with a small windfall: $2,500. I created a profile of a twentysomething novice investor who doesn't have debts and is diligently paying into a 401(k). Investor X doesn't necessarily want to lock up this money until retirement. He or she may want to buy a house, fund a year off or have something socked away in case of a car crash or other emergency.

The advice comes from five different managers, including independent financial planners as well as consultants from the likes of Schwab and T. Rowe Price. They come up with five quite different plans of action:

1. Set up a Roth IRA
2. Put some money aside in a CD
3. Be aggressive
4. ETFs!
5. Take the bond route

I don't want to critique the individual strategies. What's nice about the slant of the article is that it proposes several real-world, proactive plans that are actually achievable by a 25-year-old. It focuses on what can be done, and why. People, especially younger people with the need but without the access to the holistic advice of a wealth manager, could benefit from guidance that says, as specifically as possible, "do this."

How big is the demand for such proactive plans of action? You decide. Emily's column is #1 in the "Most Popular" links at today's WSJ.