Good News and Bad News for Americans' 401(k) Savings

white egg with 401k written on...

The pension is dead! Long live the... 401(k)!

If that sounds a bit too cheery to those who liked the idea of leaving it to their employers to figure out how to pay for their retirement, it needn't. According to a new poll from Gallup, 401(k) plans actually seem to be doing a good job of filling the gap left when America's system of employer-provided pension plans began breaking down.

%VIRTUAL-WSSCourseInline-723%Says Gallup, where employers offer 401(k) plans as an employee benefit, 89 percent of Americans choose to participate -- and a "majority" of workers say their employers do in fact offer such retirement plans. Among 401(k) participants, 96 percent say that they are "actively" contributing to their respective plans. What's more, according to investment management specialist Vanguard, by the end of 2013, the average 401(k) account had doubled in size (from 2008 levels) to more than $100,000.

That's the good news. Now here's the bad.

Hands in the Cookie Jar

Much like famed bank robber Willie Sutton, who was said to have robbed banks because "that's where the money is," when American workers come upon hard times, they often raid their own 401(k) plans to tide them over. Gallup data suggests that of workers with 401(k) plans, 21 percent have either made early withdrawals from these retirement accounts or taken out "loans" from them.

According to the poll, 16 percent of 401(k) participants have taken out loans against their accounts, 9 percent have made early withdrawals, and 5 percent have done both.

If that sounds like a bad idea, it might be -- and it might not. In the "might not be" camp, (RATE) points out that in some instances, taking out a 401(k) loan might be the least-bad option for an employee in dire straits.

Say you absolutely, positively have to have cash right now. Maybe there's been a medical emergency, or maybe you need to pay the heating bill. The interest rate charged on a 401(k) loan (generally, the prime lending rate plus a percentage point or two -- so about 5 percent today) may be much cheaper than the average interest charged on a credit card advance (now averaging 13 percent) or a payday loan (36 percent and up). In that case, taking a 401(k) loan might be an acceptable option.

Hands Off the Cookie Jar!

It's certainly a better option than making a straight early withdrawal from a 401(k) plan. That's because, when you make a 401(k) plan withdrawal before age 59½, the Internal Revenue Service charges you both income tax on the withdrawal and a 10 percent penalty on the amount withdrawn. Remember, 401(k) rules permit you to take out a loan for up to 50 percent of your total savings, up to a limit of $50,000.

Raiding your retirement piggy bank by way of a 401(k) loan is for this reason preferable to making an early withdrawal, but even here, there are downsides. For example, unlike a withdrawal, taking out a 401(k) loan may require paying a loan origination fee, administrative, maintenance, or other fees -- all of which add to the loan's cost and further drain your 401(k) balance.

Also, the IRS requires that 401(k) borrowers make regular loan repayments -- at least quarterly -- until the loan is repaid. Also, in most cases, the entire loan must be repaid within five years. Otherwise, the outstanding balance at the end of that term is deemed a withdrawal and incurs the taxes and penalties already mentioned.

Simple enough? It may be, or it may not, because circumstances outside your control may prevent you from paying back the loan or even making regular payments. Long-term illness, unemployment, or other financial difficulties may intervene, forcing the conversion of a 401(k) loan into a 401(k) withdrawal.

Your Future Is at Stake

And even in the best case, if you are able to make all the payments on your 401(k) loan, pay the interest, pay the principal, and pay it off in full and on time, all those payments must be made in after-tax dollars -- whereas your original 401(k) balance was funded with pre-tax dollars (with the exception of Roth 401(k)s). Translation: You're replacing tax-free savings with new savings that you had to pay tax on first -- but getting no additional benefit from that fact.

Long story short: Kudos, America, for taking full advantage of the availability of your 401(k) plan, and loading it up with cash. All you have to do now is make sure not to fritter it away.

Motley Fool contributor Rich Smith has never worked for an employer offering a 401(k) plan -- yet he nonetheless has a fully funded 401(k) plan of his own. He'll give you three guesses how. (Guess in the comments section below.) Also, he has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. Find out our favorite high-yielding dividend stocks for any investor in our free report.​