401k Investors Whacked With Big Penalty

Don't Dip into Your 401K

"These are unusual times and if we can be that forgiving to the investment banks of Wall Street, we need to show a little bit of consideration for working people," Galvin said.

His office has received numerous calls from worried investors who made such withdrawals -- and while he is sure they were warned of the consequences -- he still believes their judgment was clouded by fear of losing their entire savings.

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"Over the last 20 years -- mostly by the slack of support for defined benefit pension plans and the encouragement provided by Congress -- we've encouraged working people to invest in 401(k)s and be responsible for their own financial futures," Galvin added. "At the same time we've given them a marketplace that has turned out to be anything but safe."

T. Rowe Price's Ritter said he's cheered by the fact that generally, customers with the firm have kept their contributions to their 401(k) plans steady and that the number of people taking loans from their retirement accounts has actually decreased by 4 percent. Fidelity, too, has seen a decrease in 401(k) plan loans.

Taking out loans is the more common way of getting cash from a 401(k) account. Unlike hardship withdrawals, investors who take out loans from their accounts don't face tax penalties.

But that doesn't make it a good idea, financial planners say.

Kohmann said such loans are really "a last resort."

"When you take that money out -- let's say the market does pick up -- you're going to lose out on the earnings in any upswing that the market experiences while you are paying back that loan," Kohmann said.

He said loans are repaid with after-tax money. The same money is then taxed again when you make withdrawals from the account.

"Essentially, you are getting double taxed for the money you are taking out for the loan," he said.

But there are more risks. If you decide to leave your company, or are fired, you are required to pay back that loan typically in 30 to 90 days. So, in this down economy, if you take out a loan, get fired and then can't repay it, the loan is treated as a withdrawal. You have to pay income tax on it, plus a 10 percent penalty.