More Americans are raiding their retirement accounts as the cost of living rises, and experts predict that the number of employees using their 401(k)s to pay for financial emergencies may increase due to a confluence of factors, such as new facilities that facilitate withdrawals and high inflation that puts pressure on household budgets.
“It’s just more expensive to live these days, and that’s what’s getting in the way of participants,” said Craig Reid, national retirement practice leader at Marsh McLennan Agency, a benefits company. “Part of it is still a spillover from the Covid pandemic. A lot of it is inflation – just the grind of everyday life.
Mark Scharf, an IT worker in New York City, has withdrawn money from his retirement account three times since the 2008 recession. He took out more than $50,000 to pay off credit card debt, tuition for his six children to attend a religious school and, most recently, a delinquent mortgage.
“It was really a choice between saving the present versus securing the future,” he said. “My situation was not someone who is frivolous. The expenses were simply more than I earned.”
Mr. Scharf, 55, now works in the public sector and pays a pension. He calculates that if he retires at age 70, he will be able to take 40 percent of his former salary. While his retirement accounts have functioned as circuit breakers to reset his debts, he’s relieved he doesn’t have the option to withdraw his retirement contributions.
“I don’t want to have to do that again, so I force myself not to,” he said.
Mr. Scharf has a lot of company, especially lately. Two major retirement plan managers, Fidelity and Vanguard, have observed an increase in hardship withdrawals, which can only be drawn when there is “an immediate and dire financial need,” according to the Internal Revenue Service. Fidelity found that 2.4 percent of the 22 million people with retirement accounts in its system took on hardships in the last quarter of 2022, up half a percentage point from a year earlier. A similar analysis from Vanguard found that 2.8 percent of five million people with retirement accounts took a hardship last year, up from 2.1 percent a year earlier.
In the first three months of 2023, Bank of America found that the number of people taking on hardships was up 33 percent from the same period a year earlier, with employees taking an average of $5,100 each.
“Clients are much more aware that their retirement accounts are not sacred,” said Steve Parrish, an adjunct professor and co-director of the Center for Retirement Income at the American College of Financial Services. “The trend has already started. People are realizing that their 401(k)s aren’t blocked until they’re 60.”
Some experts warn that this could be just the tip of the iceberg, pointing to the many American families struggling with higher costs. While the personal savings rate peaked at nearly 34 percent in April 2020 due to Covid lockdowns and stimulus payments, it has since fallen to about 5 percent, according to the U.S. Bureau of Economic Analysis.
“What this increase in hardship withdrawals indicates in general is that people across the board don’t have enough short-term savings,” said Kirsten Hunter Peterson, vice president of thought leadership for workplace investing at Fidelity. “When that inevitable unexpected expense comes along, maybe people should look at their retirement accounts,” she said.
In addition, people often have to withdraw more money than they need to cover federal income taxes and a 10 percent early withdrawal penalty if they don’t qualify for a waiver. Exemptions can be granted for a limited number of circumstances, such as death or permanent disability.
“The cost of living is definitely pushing customers over the edge right now,” said Sarah Honsinger, a credit advisor at Apprisen, a nonprofit debt management organization.
Ms Honsinger added that the CARES Act, which temporarily relaxed restrictions around hardships in 2020, led to an increase in retirement account withdrawals.
Lawrence Delva-Gonzalez, who runs a personal finance blog called the Neighborhood Finance Guy, said he saw people in the Haitian-American community of Miami, his hometown, go to their nests without a clear view during the worst of Covid long-term consequences.
“When it came to the pandemic and it became known that you could withdraw the money early without penalty, they did,” he said.
Mr. Delva-Gonzalez said he was concerned that a lack of financial literacy would put marginalized workers like her at risk. “My community has almost no access to it,” he said.
Now that their pension money has run out, these workers face a bleak future.
“People pushing 64, 65 are basically out of options,” he said. “They have no savings and they are in debt to retire.”
Mr Delva-Gonzalez, 40, said the repercussions could spill over to the next generation, citing his own family as an example.
“Me and my wife, we already know that we’re probably going to be the people who will support my mom and her mom and her dad,” he said, an expense he said would cost several thousand dollars a month. “There’s only so much you can do before you cut your own retirement and your own lifestyle and your ability to raise a family.”
Better access to plans and money
The Secure 2.0 Act, passed by Congress last year, aims to increase workers’ access to retirement benefits, primarily by making it easier for companies to offer 401(k) plans. It also reduces the amount of red tape employees face when withdrawing money from a retirement account, and expands the list of circumstances for waiving the 10 percent penalty assessed on money withdrawn if the owner is 59½ years of age or older. is younger.
Pension experts see the legislation as a double-edged sword.
“It’s great to see Congress doing something to get more employers to offer qualified plans,” said Mr. Parrish of the American College of Financial Services. “It’s a concern on the consumer side that it might be a little too easy to get to. Great, you can get to your money – but you only retire once.
Taking money out of a retirement account has an inordinate effect on a person’s future financial security because those funds are no longer invested and the returns that connection yield. Even people who consider themselves financially savvy admit that it can be difficult to fully understand the effect on a nest egg when retirement is decades away.
A common piece of advice given to 401(k) owners who are considering withdrawing money is to take out a loan from the account instead. But as Ashley Patrick discovered, even those loans can backfire. Ten years ago, she and her husband borrowed $24,000 from his 401(k) to renovate their home near Charlotte, NC, but their payment plans went off the rails when he was laid off.
Borrowers get a five-year repayment term – provided they stay with their employer. But if they lose or quit their job, the borrower must pay back the loan by next year’s tax filing deadline. If they miss that deadline, the IRS treats the distribution as a withdrawal and applies taxes and penalties.
“We didn’t have the money,” said Ms Patrick, 38. “It had already been spent.”
In April, the couple faced a $6,000 tax bill. But the bigger loss was in the missed opportunity to keep that money invested, Ms Patrick said.
“We were in our 20s when we did this, so it would have taken a really long time to grow and have that connection,” she said. “I didn’t think about long-term costs until I started learning more about finance.”
The 401(k) as a replacement for savings
Retirement planning experts say one of the reasons there are more withdrawals today is that more employees have 401(k)s, including lower-income workers and historically disadvantaged workers, who are more likely to rely on retirement savings as emergency fund.
“The increase we’ve seen highlights and underscores the importance of having an emergency savings account as a first line of defense,” said Fiona Greig, global head of investor research and policy at Vanguard. “Historically, we’ve shown that those who take on hardship tend to be lower-income workers.”
Ms Greig said one of the reasons people dip into their retirement savings is to avoid eviction or foreclosure. “I’m starting to wonder if more problems are emerging in lower-income households,” she said.
Low-earning workers especially need the financial security provided by a 401(k) in retirement because they receive lower Social Security benefits and are more likely to have physically demanding jobs that become more difficult to perform as they age.
One possible solution, some experts say, is to have employers open emergency savings accounts for employees that are linked to their 401(k) accounts. The Secure 2.0 Act contains a provision that allows pension plan sponsors to set up these so-called sidecar accounts from 2024. Employees can contribute to after-tax earnings a little at a time, up to a maximum of $2,500, and those funds can be withdrawn without penalty.
Sid Pailla, chief executive of the Sunny Day Fund, a financial technology company that helps employees set up emergency funds, said the change would be a boon to low-income employees who would otherwise be drawing emergency funds from their 401(k).
Mr Pailla, 35, said he could relate to that kind of financial stress.
“My experience with it came quite early in my life in America,” he said.
Not long after his family emigrated from India, Mr. Pailla vividly recalled taking his parents, who spoke little English, through the byzantine process of an early 401(k) withdrawal when both lost their jobs after the dotcom crash in the nineties. .
“I was about 12 years old,” he said. “I was definitely drawn by it.”
