Although loans taken against 401(k) savings seem to have tapered off from the 2010 peak, funds intended for retirement are still being drained to pay people’s current expenses, says an organization called HelloWallet.

Taking money from 401(k) plans that are intended to pay living expenses in retirement is almost always a bad idea, says Catherine Golladay, vice president of 401(k) participant services at Charles Schwab.

Financial advisors who deal frequently with clients who may be looking for additional sources of income agree taking money from a 401(k) plans should only be done in the most extreme cases and when every other option has been exhausted.

The percentage of people estimated to have outstanding loans against their 401(k) plans varies, depending upon who is compiling the numbers. HelloWallet estimates it is about 13.7 percent, while Schwab estimates for its retirement programs it is about 16 percent, and Vanguard, one of the nation’s largest 401(k) managers, says about 18 percent. This compares to a Fidelity report of 22 percent outstanding loan rate in 2010.

HelloWallet is an online financial guidance service for employees founded by former Brookings Institution scholar Matt Fellowes.

The percentages of both loans and outright distributions have leveled off to about what they were before the recession in 2010, but they are still too high, Fellowes says. Of the $294 billion that is deposited in 401(k) plans by employers and employees each year, $70 billion is being siphoned off for non-retirement purposes, compared with $30 billion before the financial crisis. One in four employees who are plan participants dip into their retirement funds to pay mortgages, credit cards or other bills, he says.

Penalized withdrawals from 401(k) plans increased from $36 billion in 2004 to more than $60 billion in 2010, according to Time magazine.

The situation is made worse because of the drastic decline in the number of employees who are now covered by traditional defined benefit pension plans and because of talks in Congress of cutting Social Security and Medicare benefits to solve federal budget problems.

This puts the burden of financing retirement more squarely on the 401(k) plans that cover about one third of households and have a total of $3.5 trillion in assets. Some employers will not allow loans against 401(k) plans.  Most do, but the disadvantages are high, says Golladay.

“While paying back a loan, many people stop making regular contributions, which further deplenishes the retirement fund. Even though you are borrowing from yourself, you have to pay the loan back with interest and with after tax money. That money gets taxed again when you withdraw it at retirement,” she explains. The interest rate is usually the prime rate plus one or two percent.    

In addition, if you leave your job the money has to be paid back in 30 or 60 days and, if it cannot be paid back, it is taxed and there is usually a 10 percent penalty.

“Too many people think of their 401(k) plan as a piggy bank that can be tapped at any time,” she says.

“You want that money to be there when you get to retirement and you want time to be working on your side,” says Larry Rosenthal of Rosenthal Wealth Management Group in Manassas and McLean, Va. “Therefore you should explore every other option first before borrowing from your 401(k).”

Rosenthal says he sees very little activity in loans or distributions from 401(k)s, but he knows it happens as people become cash strapped.

“There was a couple in here just the other day who were considering using a $250,000 retirement fund for expenses. I told them not to,” he says.

Mark  D. Kemp, CFP, president of Kemp & Associates Retirement Services in Philadelphia, agrees. He says younger people are worse at saving than those over 50, who are more reluctant to tap into retirement accounts.

“Those under 50 do not view retirement savings as a long-term commitment,” he says. “They see it as delayed spending. Loans against a 401(k) plan may be better than using a credit card because the interest rates are lower, but it is still not a good idea.”

Ben Barzideh, a wealth advisor at Piershale Financial Group in Crystal Lake, Ill., suggests setting up an emergency fund in the budget before setting aside money for retirement. That way the emergency fund can be tapped first before any withdrawal from a 401(k) plan that would have a penalty attached is touched.

Advisors say the only thing that might justify taking a loan against retirement savings would be to help a relative who is in dire need of money, to take advantage of a really good real estate deal while interest rates are so low, or to help with a last year of a child’s college.

Certain tricks do exist to make a loan or distribution a little more palatable.

If a withdrawal has to be made, it will be subject to regular income taxes.  If it is near the beginning of the year, wait until after Jan. 1 and taxes will not be due until 15 months later, says, Mark E. Miehe, independent financial advisor with Midwest Financial Group Inc. in Madison, Wisc.

When an employee leaves a job he can roll over a retirement plan to a new employer or an IRA or take a disbursement. If the cash is needed, advisors recommend taking only as much as needed as a disbursement and rolling as much over as possible to limit the taxes and penalties.

After age 59 1/2 disbursements can be taken without the 10 percent penalty.  However, if a person retires is fired or quits after he is 55 he can also withdraw money without a penalty.

There is also a provision known as the 72(t) distribution rule that advisors say some people are not aware of. It allows a person to take substantially equal periodic payments from a 401(k) regardless of age. The payments must continue for five years or until the person reaches 59 1/2, whichever is longest.