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Lure of 401(k) loans puts pressure on retirement

Four years ago, Bill and Ann Essary, their two children and their dog were living in a motel room here on the flat Sacramento delta northeast of San Francisco. Essary was working as a truck driver, although the pay was poor and he had no benefits. It took a little time, but he finally landed a better job with a dairy distributor _ a job with a 401(k) retirement plan.

The job's higher pay enabled the family to move out of the motel and into a rented house. And its 401(k) plan, from which the dairy company allows workers to borrow, enabled the Essarys to raise their quality of life by buying such big-ticket items as a motorboat.

Does it bother the Essarys that they are using their retirement plan like a piggy bank? "I can't worry about retirement in 25 years," says Mrs. Essary, who, at age 45, has had a dozen surgeries for cancer, kidney failure and other serious illnesses. "I could die before that." Mindful of all this, she says, the notion that her husband's 401(k) ought to sit untouched until old age seems foolish.

The 401(k) revolution _ the radical swing in retirement savings away from conventional pension plans toward do-it-yourself plans _ has transformed the way Americans juggle their immediate and longer-term financial needs. Whereas their parents and grandparents couldn't touch their retirement money until they actually retired, employees with 401(k) plans have an astonishing amount of access to their old-age nest eggs. Modern retirement plans are, for better or worse, irresistible pots of money available for the here-and-now.

Most 401(k) plans _ funded by employees' payroll deductions and often by employer contributions as well _ permit employees to borrow from the accounts' assets, and millions do. In fact, a third of all workers with 401(k)s currently have loans outstanding. Those most likely to borrow their retirement money are lower-income employees with fewer assets and greater debts, according to Congress' General Accounting Office.

No wonder. For many workers, the money in their 401(k) is the largest asset they have. And while higher-income employees tend to earmark their savings exclusively for retirement, lower-paid workers _ particularly those who don't qualify for mortgages, auto loans or credit cards _ are discovering that their retirement account is a handy, low-cost source of credit.

All this has created a quandary for American families of modest means: Should they dip into their swelling nest eggs or leave them untouched and growing until retirement? There is no question that in the case of the Essarys, the ability to tap Bill's 401(k) is a mixed blessing.

On one hand, it enables the family to enjoy some of the middle-class comforts they would otherwise have to do without, and to help out family members in distress. But it most assuredly leaves them less prepared for old age, because money that isn't in the retirement plan isn't invested, and it certainly isn't growing with the stock market. Yet the Essarys' attitude is: Why worry about tomorrow when there is plenty to worry about today?

"It's the cheapest loan in town," Mrs. Essary says of her husband's retirement plan. With a secured credit card, she notes, you can spend only what you put into the account, and you have to pay it back before you can use the card again. With the 401(k), Essary can repay any loan through payroll deduction. And instead of paying the 21.9 percent or so interest that is typical of secured credit cards, he pays the prime rate at the time of the loan plus two percentage points _ in his case, 10.25 percent. Perhaps best of all, the interest payments Essary makes go right back into his own retirement account.

At Super Store Industries, the Stockton, Calif., dairy distributor that employs the 38-year-old Essary as a milk-truck driver, most of the employees who take out loans against their 401(k)s are part of younger blue-collar families, says Tim McGarvey, vice president of human resources. More than half of the 644 Super Store workers with 401(k)s have loans outstanding.

"Probably too many have loans," McGarvey says. But as he sees it, if employees couldn't get at their money easily, many wouldn't participate in the retirement-savings program in the first place.

On a hot autumn Saturday, Mrs. Essary returns from coaching her daughter's Little League baseball team and sits in the dining room, sifting through her husband's 401(k) statements and retirement-plan documents, which would appear to be written in Sanskrit. "Ninety percent of the guys get this stuff in their cubbyholes and throw it out," she says. "I'll read it and reread it till I can recite it back to you."

Essary is about to get a raise, and his wife is trying to figure out how much he should increase his loan repayments. Bill, who has just returned from his usual 12-hour graveyard shift plus overtime, sleepily fries up chicken and fixes potato salad for supper while his wife lays out their strategy.

"I see no reason to take this extra pay and spend it," she says. "This is not the entertainment portion of the program. To Bill, payday is reward day. He's in it for having fun. I'm in it for the pain."

Essary shrugs.

His wife continues, "I tell him, you want to p--- it away at Target, or save it? We don't argue about money. There isn't enough to argue about, anyway."

Essary nods.

Essary's retirement plan has become the means to pay for many things. Just six months after he began his contributions of pretax dollars to the plan, his mother had kidney failure. He borrowed the $1,200 he had saved in the plan to cover the family's bills during a leave of absence he took then.

As soon as he paid back that first loan, Essary took out a second loan, in March 1996, for $1,200 and bought a used trailer to take the kids camping at nearby Lake Berryessa.

After repaying that loan, he took out a third. He now had $4,000 of his own money in his account _ having continued making contributions and repaid all loans _ and he borrowed it all. The Essarys wanted to buy the home they were renting, and they intended to use the loan to pay the bank fee for an owner-financed mortgage.

The deal fell through. But instead of putting the borrowed money back into the 401(k), they spent $1,400 on a 17-year-old motorboat (a 17-footer with a Chrysler 360 engine), paid off $947 in credit-card bills and gave some money to Mrs. Essary's 26-year-old son from an earlier marriage, a graduate student whose wife was expecting a child.

The Essarys put the remaining $800 into an account with a credit union, earning 5 percent. Three months later, they used it toward a down payment on a 1987 Dodge Ram three-quarter-ton pickup. The borrowed 401(k) money enabled them to qualify for a truck loan with monthly payments spread out over one year instead of three. Mrs. Essary figures the shorter term will save $2,000 in interest payments.

"I have to juggle it all," she says. "If I only had my eye on retirement, it would be pretty simple. But life isn't simple."

But what about the trade-off? When families borrow from a 401(k), they typically end up with less income in retirement (as much as 20 percent less, according to the GAO), because they lose the ability to earn a return on the money while it is outside their accounts.

So how much money would the Essarys have in Bill's retirement plan if they had never borrowed from it? Probably about $15,000. Instead, they have $10,835, most of which is the employer's contribution and earnings on that.

The longer the Essarys take to repay their loans, of course, the more investment income they forgo.

At Super Store, McGarvey, the human resources executive, says the company is making a calculated tradeoff, too. Super Store knows that employees are reducing their future retirement income by taking out loans. But McGarvey acknowledges that the company wants to increase participation among such lower-paid employees because, under federal pension law, if too few such workers enroll, then the higher-paid employees can't contribute the maximum allowed by law, currently $9,500.

Mrs. Essary has no regrets about shrinking tomorrow's account for today. "They told me I'd be dead in 1979," she says. "I have a lot of illnesses that could creep up and kick me out. It wouldn't matter if I had this big retirement fund. I have a finite period of time on this planet."

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