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Escrow isn’t the most euphonious word, but it’s important when you’re a homebuyer and homeowner. In real estate transactions, escrow is the process of keeping money in trust until certain conditions are met. There are a couple different ways that escrow might be used, so let’s look more closely at this important process.

What Is Escrow?

There are a couple of ways that escrow is used. The first time you might encounter it is during the home-buying process, when your good-faith deposit (also known as “earnest money”) is held in escrow until the sale is finalized.

The funds are kept in the care of an escrow agent, who ensures that the deal terms are met by both sides. This protects both the buyer and the seller during the homebuying journey, which can sometimes be bumpy.

After you purchase a home, an escrow account is often used again as a way to help the mortgage lender ensure that an owner pays property taxes and home insurance fees in a timely and consistent fashion (more on that later). In this scenario, your mortgage loan payments will include taxes and insurance. An escrow account set up by the lender or mortgage servicer will accrue that portion of your monthly payment and pay the tax and insurance bills when they’re due.

We’ve all seen them: houses that look forlorn, decrepit, unlived in. Maybe the weeds are tall and the paint is peeling. These are signs of a zombie foreclosure: a homeowner essentially abandons the property, often after receiving a notice of impending foreclosure.

What Is a Zombie Foreclosure?

A zombie foreclosure typically occurs when a homeowner defaults on their mortgage and believes they must vacate the premises immediately. In other cases, the homeowner may leave for any number of other reasons.

Even if someone defaults on a mortgage, they are not absolved from all responsibilities until the lender completes the foreclosure process. Until then, the homeowner is usually still responsible for the mortgage, maintenance, homeowners association (HOA) fees, and other costs.

At last count, more than 8,000 zombie homes existed nationwide, with overall numbers increasing 5.4% from late 2022 to early 2023. The greatest number of zombie foreclosures is in New York, Florida, and Ohio. Although the number of zombie homes remains small, it will likely continue to increase as foreclosure rates increase.

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How Does a Home Become a Zombie Foreclosure?

A zombie foreclosure can sound scary, but it’s best to be aware of how they happen to avoid the worst consequences. A home often becomes a zombie foreclosure after the homeowner defaults on the mortgage. When this happens, the homeowner typically receives a foreclosure notice from the mortgage lender. They might believe they must leave immediately, abandoning their home as a result.

But while they turn their back on a home they believe has “died,” the home lives on and still has a laundry list of responsibilities. This means mortgage payments, maintenance, HOA fees, property taxes, and more. The current homeowner still holds the title and is still responsible for all these items until the foreclosure process is complete.

Complicating the picture, lenders sometimes decide not to complete the foreclosure process. There can be many reasons for this, but the most common is that the lender determines that foreclosing on the home isn’t worth it. Foreclosed homes often need significant repairs, and there might be a large amount of back taxes to pay.

While zombie foreclosures only make up a small percentage of all foreclosures, they do happen. Just because someone receives a foreclosure notice doesn’t mean the home is no longer their responsibility. That’s why it’s wise to follow up with the mortgage lender and await official communication before leaving for good.

Consequences of a Zombie Foreclosure

A zombie foreclosure is not a good thing for anyone involved. There can be a range of issues for the owner and the home’s neighbors.

Impact on Homeowners

As mentioned earlier, you are still responsible for your home if you receive a foreclosure notice. If you abandon the property before the foreclosure process is complete, you might face some serious consequences:

•   Penalties and fees: If the foreclosure process drags on, it could result in the accrual of interest, penalties, and fees. These can increase the financial burden you were already experiencing.

•   Damage to your credit: A zombie foreclosure can seriously damage your credit because it may result in a home mortgage loan default. This can make it very difficult to obtain loans in the future, including new mortgages, auto loans, and personal loans.

•   Legal consequences: Not making your payments could result in a variety of lawsuits. For instance, the city might sue you over unpaid property taxes. Or the homeowners association might sue you to collect its fees.

As you can see, the consequences of a zombie foreclosure can be significant. Therefore, seeking legal advice to understand your rights and responsibilities in these situations is best. In addition, you should ensure all paperwork is complete before you leave the property for the last time.

Impact on Neighbors

The homeowner who abandons a property may not be the only one who suffers. There may also be consequences for neighbors:

•   Increase in crime: Squatting, vandalism, and theft are just a few of the types of crimes that might occur after a zombie foreclosure.

•   Public health issues: Foreclosed homes are often neglected, leading to overgrown yards. This can attract mosquitoes and other pests that can spread diseases.

•   Costs for the local government: Someone must take care of a neglected home, and that job often falls to the local government. This can then lead to higher taxes for people in the area.

Impact on the Housing Market

The broader housing market can also be impaired due to zombie foreclosures. However, some opportunistic investors may also take advantage of the situation. Here are some of the potential impacts on the local housing market:

•   Decrease in property values: A zombie foreclosure can cause a home to become an eyesore and a hazard to the local community. This can make the neighborhood less desirable as a whole, leading to a decrease in property values across the board.

•   Decrease in new construction: New builders may be hesitant to pursue projects where there are zombie foreclosures. They might believe they can’t compete with the low prices of foreclosed homes.

•   Opportunities for investors: While zombie foreclosures’ impacts are mostly negative, they can also lead to opportunity. Investors can purchase these homes at bargain-bin prices, renovate them, and either sell or rent them.

While they can create opportunities for investors, most zombie foreclosures’ impacts on the housing market are negative. As a whole, local communities generally suffer the consequences as a result. One way for owners to reduce the risk of a zombie foreclosure is to ensure a home is affordable for them from the outset.

Considerations If Purchasing a Zombie Foreclosure

While zombie foreclosures may have a discounted price tag, there is much to consider before moving forward. First, there can be legal complexities that complicate the process. For instance, the home may be in pre-foreclosure, the foreclosure may not have been properly completed, or there may be liens on the property. You must understand these complexities when purchasing a zombie foreclosure. Working with a real estate attorney with experience in this area is best.

You should also consider the condition of the property. Those that have been abandoned can have a range of issues, such as structural damage, mold, or vandalism. Some of these issues are more costly to fix than others. Thus, the home will need a thorough inspection to understand what repairs it may need.

Another important consideration is financing. Some lenders might be hesitant to finance homes in poor condition. You might need to explore alternative financing options, such as a renovation loan. Or you might even have to pay cash. Either way, more flexibility may be necessary when dealing with zombie foreclosures.

The Takeaway

Zombie foreclosures typically occur when a homeowner vacates the premises after receiving a foreclosure notice but before the foreclosure process is complete. Zombie foreclosures can hurt both homeowners and the local community. Therefore, homeowners may want to avoid this situation by remaining in their homes until they receive a notice to vacate and trying to stay current on mortgage payments, property taxes, and HOA fees.

Mortgages can be complicated, but SoFi Home Loans tries to make things simple.

FAQ

What are zombie mortgages?

Zombie mortgages are outstanding home loans that borrowers have stopped making payments on, often because they thought the debt was forgiven or settled long ago. In some cases, these can be second mortgages that a borrower may not even be aware of. It is not always legal for lenders to try to collect on these debts.

What is the foreclosure rate in the United States?

The foreclosure rate is 1.3% in the United States, according to the second-quarter 2023 Vacant Property and Zombie Foreclosure Report from ATTOM Data Solutions. While an increasing number of homeowners have faced foreclosure since the nationwide foreclosure moratorium was lifted, foreclosure rates are historically low.

What city has the most foreclosures?

Among cities with a population of at least 200,000, the top three foreclosure rates for the first quarter of 2023 are in Fayetteville, North Carolina (one in every 526 housing units), Cleveland, Ohio (one in 582), and Atlantic City, New Jersey (one in 661), according to ATTOM Data Solutions.

Photo credit: iStock/Derek Broussard

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A salary reduction contribution plan allows employees to reduce their taxable income by investing for retirement. With this type of plan, an employee’s salary isn’t really reduced; rather the employer deducts a percentage of their salary and deposits the funds in a retirement savings plan where the money can grow tax deferred.

Common employer-sponsored retirement plans include 401(k)s, 403(b)s, and SIMPLE IRAs. Employee contributions — also called elective deferral contributions — are typically made with pre-tax money, effectively reducing the participant’s taxable income and often lowering their tax bill. Some plans feature an after-tax Roth contribution option, too.

You may already be contributing to a salary reduction contribution plan, although your company may not call it that. These plans can be a valuable way to boost your retirement savings, and offer you a tax break. Here’s what you need to know.

Salary Reduction Contribution Plans Explained

A salary reduction contribution plan helps workers save and invest for retirement through their employer via several types of retirement accounts. Money is typically deposited in a retirement account such as a 401(k), 403(b), or SIMPLE IRA on a pre-tax basis through recurring deferrals (aka contributions) on behalf of the employee.

Employees typically select the percentage they wish to deposit, e.g. 3%, 10%, or more. That percentage is deducted from an employee’s paycheck automatically, and deposited in their retirement account. Sometimes a specific dollar amount is established as the salary reduction contribution amount.

The upshot for the worker is that they can delay paying taxes on the amount of the salary reduction for many years, until they withdraw money from the account during retirement. Like a traditional 401(k) or 403(b), these accounts can be tax deferred; Roth options are considered after tax (because you deposit after-tax funds, but pay no tax on withdrawals). Retirement contributions may offer decades of compounded investment returns without taxation. Essentially, retirement contributions through an employer’s plan means saving money from your salary.

There are also SIMPLE IRA salary reduction agreements sometimes offered by small businesses with 100 or fewer employees: “SIMPLE” is short for “Savings Incentive Match Plan for Employees.”

A Salary Reduction Simplified Employee Pension Plan (SARSEP), on the other hand, is a simplified employee pension plan established before 1997.

How Salary Reduction Contribution Plans Work

Salary reduction contribution plans are established between a worker and their employer. The two parties agree to have a set percentage or a dollar amount taken from the employee’s salary and deposited into a tax-advantaged retirement plan. That money can then be invested in stock or bond mutual funds, or other investments offered by the plan.

With pre-tax contributions, the employee has a reduced paycheck but gets current-year tax savings. With after-tax contributions, as in a Roth account, taxes are paid today while the account can potentially grow tax-free through retirement; withdrawals from a Roth account are tax free.

Example of a Salary Reduction Contribution Plan

Here’s an example of how a salary reduction contribution plan agreement might work:

Let’s say an employee at a university has a $100,000 salary and wishes to save 10% of their pay in a pre-tax retirement account. The school has a 403(b) plan in place. The worker contacts their Human Resources department to ask about submitting a salary reduction agreement form. On the form, the worker chooses an amount of their salary to defer into the 403(b) plan (10%).

Typically they also select investments from a lineup of mutual funds or exchange-traded funds (ETFs).

Come payday, the employee’s paycheck will look different. If the usual biweekly gross earnings amount is $3,846 ($100,000 salary divided by 26 pay periods, per year), then $384.60, or 10% of earnings, is deducted from the employee’s paycheck and deposited into the 403(b) and invested, assuming the employee has selected their desired investment options.

Depending on other deductions, the employee’s new taxable income might be $3,461.40. The contribution effectively reduced the worker’s salary, potentially lowering their tax bill at the end of the year.

If the worker is in the 22% marginal income tax bracket, the $10,000 annual deferral amounts to an annual federal income tax savings of $2,200 per year.

Bear in mind that withdrawals from the 403(b) plan are taxable with pre-tax salary reductions. We’ll look at salary reduction plan withdrawal rules later.

Pros & Cons of Salary Reduction Contribution Plans

Although your employer may offer a salary reduction contribution plan like a 401(k) or SIMPLE IRA salary reduction agreement for retirement, it’s not required to participate. Before deciding whether you want to join your organization’s plan, here are some advantages and disadvantages to consider.

Pros

A salary reduction contribution offers employees the chance to reduce their current-year taxable income. A lower salary defers taxation on the money you save, until retirement. For young workers, that could mean decades of compounding returns without having to pay taxes along the way.

For those who have the option of choosing to open a Roth account, taxes are paid in the current year, but withdrawals are tax free (as long as certain criteria are met). Also, contributions to a Roth 401(k) or Roth 403(b) plan can grow tax-free through retirement.

What’s more, the employer might offer their own contribution such as a matching contribution. Typically, an employer might match employees’ contributions up to a certain amount: e.g. they’ll match 50 cents for every dollar an employee saves, up to 6% of their salary.

Another upside is that lowering one’s salary through automated savings can help an individual live on less money and avoid spending beyond their means — which may help establish long-term savings habits. Thus, contributing to a salary reduction plan can be a step toward creating a financial plan.

Cons

Like many aspects of personal finance, salary reduction contributions can be a balancing act between meeting your obligations today and providing for your future self.

Saving for the future can mean forgoing some pleasure in the present, similar to the concept of delayed gratification. Maybe you decide to postpone a vacation or purchase of a new car in exchange for a more robust retirement account balance.

Employees should also weigh the likelihood of needing money in the event of an emergency. Taking early withdrawals or borrowing from your 401(k) account can be costly, or may come with penalties, versus having extra cash in a checking or savings account. In most cases if you take out a loan from an employer-sponsored plan, you would have to repay the loan in full if you left your job.

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Salary Reduction Contribution Limits

Annual salary reduction contribution limits can change each year. The Internal Revenue Service (IRS) determines the yearly maximum contribution amount. For 2024, the most a worker can contribute to a 401(k) or 403(b) is $23,000. For those age 50 and older, an additional $7,500 contribution is permitted.

In 2025, a worker can contribute up to $23,500 to a 401(k) or 403(b), and those 50 and older can contribute an additional $7,500 in catch-up contributions. For 2025, those aged 60 to 63 may contribute an additional $11,250 (instead of $7,500) to their 401(k) plan.

A SIMPLE IRA salary reduction agreement has different limits. For 2024, a SIMPLE IRA’s annual maximum contribution is $16,000 with a catch-up contribution of up to $3,500 for those age 50 and older. For 2025, the annual maximum SIMPLE IRA contribution limit is $16,500 and $3,500 for those 50 and up. For 2025, those aged 60 to 63 may contribute an additional $5,250 (instead of $3,500) to their SIMPLE IRA.

Salary Reduction Contribution Plan Withdrawal Rules

There are many rules regarding salary reduction contribution plan withdrawals.

At a high level, when an employee withdraws money from a tax-deferred retirement account, they will owe income tax on the money. If you withdraw money before age 59 ½, a 10% early-withdrawal tax might be applied.

There can be some exceptions to these rules, but it’s best to consult with a professional.

Should you withdraw money when you leave your employer? While taking a lump sum is possible under those circumstances, it may not be your best choice: You’d owe taxes on the full amount, and you’d risk spending money that’s meant to support you when you’re older.

The standard rule of thumb is that individuals who are leaving one employer should consider rolling over their retirement account to an IRA, or their new employer’s plan. In that case there are no penalties or taxes owed, and the money is once again secured for the future.

The Takeaway

Salary reduction contribution plans can help workers save money for retirement on a pre-tax or after-tax basis. Steadily putting money to work for your future is a major step toward building a solid long-term financial plan. And in many cases you will reap a tax advantage in the present — or in the future.

That said, there are important pros and cons to weigh when deciding whether you should contribute via a salary reduction plan. You may have another strategy. But if you don’t, you might want to consider opting into your employer’s plan for the benefits it can provide.

An important point to know: Even when you join a salary reduction plan, you can still open up an IRA online to boost your savings. And if you leave your job, you can roll over your salary reduction retirement account to an IRA without paying taxes or penalties.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

FAQ

Does a 401(k) reduce salary?

Not really. Contributions toward a traditional 401(k) retirement plan are a tax-deductible form of savings that effectively reduce an individual’s taxable income. In that regard, making retirement contributions on a pre-tax basis can reduce someone’s salary (but you still have the money in your retirement account).

Also, some plans allow for after-tax contributions which also reduce the size of your paycheck, but are not tax deductible.

What does employee salary reduction mean?

Employee salary reduction means that money is automatically deducted from an employee’s paycheck and contributed to a retirement plan. Money moves into a plan such as a 401(k), 403(b), or a SIMPLE IRA. The account is in the employee’s name, and they decide how to invest the funds.

What is the difference between SEP and SARSEP?

A SEP is known as a Simplified Employee Pension Plan. A SEP plan allows employers to contribute to traditional IRAs (called SEP IRAs) for their employees. The IRS states that a business of any size, even self-employed, can establish a SEP. These plans are common in the small business world.

A SARSEP, on the other hand, is a simplified employee pension plan established before 1997. A SARSEP includes a salary reduction arrangement. The employee can choose to have the employer contribute a portion of their salary to an IRA or annuity. Per the IRS, a SARSEP may not be established after 1996.

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