What's going on here? The answer is a significant opportunity for financial advisors who are well versed in retirement plan liquidity issues. Employers are worried that their plans are not working as designed to build retirement security, and that matching contributions are going up in smoke. Most participants don't understand when and how it makes sense to tap retirement assets for liquidity needs, and when it's a bad idea.

If you can offer answers to these questions and concerns, you will open doors to plan decision-makers, takeover opportunities, and distribution /rollover events. Consider this article a quick guide for gearing up your liquidity counseling knowledge and services.

A Scenario to Frame Your Services

To understand the need for retirement plan liquidity counseling, let's begin with a hypothetical scenario. Betsy is the owner of a small company with 40 participants in a 401(k). She says: "Until recently, I thought our plan was a great idea. Now, I'm not so sure. More than half of our employees are hourly and earn $10-15 per hour. We have worked hard to encourage them to join the plan. We also match 50% of their deferrals up to 6% of pay. But recently, we have been being inundated with requests for loans and withdrawals. It's expensive and time-consuming for a small company to answer these requests, and it makes me wonder what we are accomplishing. I'm starting to wonder whether many of our employees aren't making progress with their retirement savings, and whether our matching contributions are a waste of money."

Juan is an hourly employee who works for Betsy full-time, bringing home about $500 per week. He says: "At first, I didn't think I could afford to join the plan, but Betsy asked me to try. For a few years, everything went fine. Then, my wife got pregnant and had to stop working. Our mortgage payments, grocery bills and heating oil costs increased, and we fell behind on our credit cards. Now, I have no choice but to tap as much plan money as I can."

How do you resolve this dilemma? The short answer is – there's nothing to resolve.

Participant-directed retirement plans are one innovations of the U.S. economy that work well for everyone even when times get tough. Both Betsy and Juan are better off with a 401(k) plan than without one, especially when you explain the situation and show them how to make "liquidity events" work better. The information you can communicate falls under the seven key points covered below.

1. The Saver's Credit and Employee Matching

There is no better place for Juan to save money than in his 401(k) plan. The Pension Protection Act of 2006 made permanent a form of "government matching" through a non-refundable federal tax incentive called the Saver's Credit. It effectively reimburses up to 50% of the first $2,000 that a moderate-income worker contributes to any type of qualified retirement plan. For 2008, the income thresholds and credit amounts are shown in the table below.

Example: Juan files taxes jointly and has AGI of $30,000. He defers $1,500 into his 401(k), approximately 5% of his pay. By qualifying for the highest rate of 50% (as shown above), he earns a credit of $750. Therefore, the out-of-pocket cost of his deferral is just $750. He also receives an employer matching contribution equal to 50% of his own deferrals, another $750. His 401(k) account immediately earns a 100% return on his out-of-pocket cost.

Observation: It is often the modest-income worker who needs access to 401(k) money for liquidity. But when such workers qualify for both the Saver's Credit and employer matching, it almost always makes sense to participate in the plan first and evaluate liquidity issues later. You can offer workers a valuable service by illustration their "immediate return" on out-of-pocket deferrals, as in the example above.

2. Access to Plan Loans

Most 401(k) plans offer access to loans in amounts of up to the lesser of $50,000 or 50% of the participant's vested balance. These loans can often be the best available source of short-term liquidity, and in the past they have not been used excessively or abusively. The Employee Benefits Research Institute (EBRI) estimated that $49 billion of loans were outstanding in U.S. 401(k) plans at the end of 2006, and this represented only about 2% of the $2.7 trillion in 401(k) plan assets. According to EBRI, only about 20% of all active plan participants have had loans outstanding, and the average loan balance has averaged about 15% of the account balance. Participants in their 30s or 40s are more likely to take loans than those who are younger or older.

Most loans must be repaid on a five-year amortizing basis, and any charged interest is repaid directly to the participant's account. Loans made for the purchase of a primary residence may be repaid over up to 15 years. Credit applications are not required to qualify, and all participants must be given equal access to loans (when they are offered by the plan) regardless of credit history or score. This makes 401(k) loans one of the best liquidity sources for people who lack a strong credit record or access to traditional sources of finances.

Observation: Betsy is not required to offer loans in her company's plan, but it is in everyone's interest for loans to be available. In a financial pinch, Juan could borrow 50% of his own deferrals shortly after they are made. He would still be making savings progress due to employer matching and the Saver's Credit. After Juan's financial situation improves and his loan is repaid, he would be back on track toward his retirement goals, assuming that the loan interest rate is approximately the same as the lost investment opportunity on 401(k) plan investments. (Note that there is no third-party borrower in a 401(k) plan loan. Plan investments are liquidated to make the loan.)

Myth: Contrary to some published accounts, a 401(k) plan loan does not produce positive or negative tax impact. The loan itself is not taxable income, provided it is repaid. Loan repayment is made with after-tax dollars, the same as in loans from a bank or other financing source.

Betsy needs a qualified financial professional to help her communicate these facts about plan loans to all participants. The tone of this communication should be neutral – i.e., loans are not necessarily good or bad, but they are can help to meet legitimate liquidity needs quickly and easily.

3. The Impact of Loans on the Sponsor and Other Participants

Betsy worries that loans are distracting and costly for the company and plan. Too many loan requests are taking too much time, and the cost of processing loans is nicking all participants. However, you can offer solutions to this problem in the form of technology-enabled recordkeeping systems with self-service features and individual account fee billing.

For example, the ReservePlus program was developed by financial inventor Bruce Bent and his company, Reserve Solutions, and it could ultimately enhance the liquidity of participant-directed retirement plans just as another of Bent's inventions, money market funds, did for mutual funds. (He created the Reserve Fund, the first money market mutual fund, launched in 1970.). Most of the media attention on ReservePlus has focused on whether it turn 401(k) plans into the equivalent of ATM machines by enabling easy borrowing. But a more important feature may be a platform interface that automates all aspects of plan loan transactions, creating direct links between participants and recordkeepers and taking employers out of the loan loop. Participants directly apply online for a loan that works like a line of credit and can then be tapped multiple times, in small amounts, via a debit card or ATM machine. The interface also has the ability to bill participants directly for loan processing and platform fees, so that the cost impact of each loan does not affect the sponsor, the plan or other participants. For more information about ReservePlus, visit the company's Website at:

• http://www.reservesolutions.com/index.htm

Several other leading recordkeepers also offer direct loan interfaces and individual account fee billing options. You can provide a valuable service by helping sponsors reduce the worries of loan administration by upgrading to a high-tech, Internet-enabled turnkey plan or recordkeeping system.

4. Hardship Withdrawals

While technology has made plan loans simpler, another important source of liquidity, hardship withdrawals, remains complex and difficult. A hardship withdrawal request requires a plan administrator to document a stated need for funds based on an immediate and heavy need, and all withdrawals are subject to ordinary income tax. Under IRS regulations, only employee deferrals (and earnings on them) may be withdrawn. In addition, the IRS that the distribution must satisfy the immediate and heavy need, which means that the participant must provide proof of having tried to obtain the money from other sources. Unless the withdrawal is made for specific reasons, an additional 10% federal tax penalty is assessed. Those reasons are:

1. Total and permanent disability
2. Excessive medical costs
3. A court order to distribute retirement funds to an ex-spouse or dependents
4. Separation from service at age 55 or later

Plans are not required to offer hardship withdrawals. If they are offered, plans they may discourage participants from taking them in several ways ? such as by limiting the ability to defer money or qualify for employer matching contributions for a period of time after any hardship withdrawals are taken – and you should help sponsors evaluate the disincentives. Then, you can offer to individually counsel any participant who requests a hardship withdrawal. This counseling should cover: 1) the heavy long-term costs of these permanent withdrawals in lost retirement savings progress; 2) the negative tax consequences; and 3) an evaluation of alternative sources of liquidity that may be more cost-effective. Also, you can encourage participants to anticipate liquidity needs before they become dire, to avoid the "emergency" nature of many hardship withdrawals.

In the current environment, you may need to help some participants decide whether a hardship withdrawal is warranted to avoid foreclosure on a home mortgage. While a foreclosure can create temporary financial pain and damaged credit, the permanent loss of retirement assets can have even greater longer-term consequences. Help participants maintain an emotional commitment to their long-term retirement plan savings programs, even when they are enduring financial uncertainties and difficulties in the present. While such counseling may not directly put money in your pocket, it can build goodwill with plan sponsors by relieving them of hardship withdrawal administrative burdens.

5. Eligibility and Vesting

Employers can take steps to make sure company contributions are not diminished by liquidity events. By adopting the maximum eligibility requirement allowed by law (one year) and also the maximum "cliff" vesting schedule allowed (three years), employers can make sure that no employer contributions are used for loans until a participant enters the fifth year of service. You also can help to educate participants on the fact that only their own deferrals and vested employer contributions (plus earnings on them) are eligible for loans, and only their own deferrals (plus earnings) are eligible for hardship withdrawals.

6. In-service Distributions

Unless a hardship is documented, federal law does not allow 401(k) plans to make distributions to active participants until they have reached retirement age. However, plans may choose to allow in-service distributions of all vested amounts to participants who have reached the plan's normal retirement age. In addition, plans may authorize limited in-service distributions of specific types of contributions to even younger workers. The terms for accessing in-service distributions must be described in plan documents. The IRS rules for these distributions are complex, and the services of a qualified attorney may be advisable to amend plan documents. The rules are located here:

• http://www.irs.gov/irb/2007-24_IRB/ar06.html

Observation: Enabling in-service distributions can help plans avoid the paperwork required to document hardship withdrawals for some workers. These distributions also can provide liquidity to older workers who wish to stay employed but phase-down their work commitment gradually. After you help sponsors evaluate in-service distributions, you also can assist them in providing distribution counseling. Participants who receive in-service distributions can continue their retirement progress tax-efficiently by making a direct transfer to either a Traditional or Roth IRA.

7. The Alternatives

Small companies that feel besieged by 401(k) liquidity events may be interested in reviewing alternative plan structures. In either SIMPLEs or SEPs, the employer makes contributions directly into the participant's own IRA. No loans are allowed, and there are no restrictions on participants' ability to take taxable distributions. The penalty on premature distributions is the same as in 401(k) hardship withdrawals (10%) with one exception: During the first two years of participation, distributions from a SIMPLE are subject to a 25% penalty, unless an exception applies.

Observation: In a SIMPLE, lower-income workers can take advantage of both employer matching contributions and the Saver's Credit, as in a 401(k). However, due to the absence of loans, participants' ability to participate in these benefits may be more restricted by liquidity concerns. For example, in our hypothetical example, Juan should be encouraged to participate in a 401(k) plan even if he anticipates a near-term need for liquidity, due to the ability to quickly and easily borrow 50% of his own deferrals. By repaying the loan on schedule, he can put his retirement savings program back on track. But in a SIMPLE, his decision on whether to participate is not be as clear-cut, due to the permanent loss of retirement savings created by a withdrawal and also the impact of any penalty on premature withdrawals.

In Summary

It p't yet clear whether the increase in liquidity events reported by some 401(k) vendors has become a meaningful trend. If so, it remains to be seen whether increasing volumes of loans and withdrawals will reverse as the economic cycle runs its course and the U.S. economy starts to improve.

However, for purposes of motivating companies in your market to adopt or upgrade qualified plans, it really doesn't matter. 401(k) plans were designed with the flexibility to permit both long-term retirement savings and near-term liquidity needs. Most liquidity features built into 401(k)s also are available in other types of participant-directed plans, such as 403(b) and 457 plans.

Many plan sponsors are worried about the increasing costs and administrative burdens of liquidity events. They want participants to receive professional guidance before making irreversible mistakes, such as taking hardship withdrawals when less-costly loans are available. They also may want advice on how to upgrade existing plan features to make liquidity events less burdensome on the sponsor, the plan and other participants.

If tough economic times are driving liquidity events, then these times could be your ticket to capturing takeover plan opportunities and distribution-event rollovers. Start putting the knowledge contained in this article to work in your market today. Turn the lemon of a weak economy into the lemonade of higher personal earnings.

Note: More useful information about 401(k) plan liquidity events is found in 12 Steps to Your Personal Success in the 401(k) and Small Plan Market, a book written by the author of this column. For more information and to order:

• http://www.judydiamond.com/cgi-bin/jda/success