More Americans are raiding their retirement accounts as the cost of living rises, and experts predict that the number of workers turning to their 401(k) plans to pay for financial emergencies could increase due to a confluence of factors, such as new provisions 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 putting pressure on respondents,” said Craig Reid, national retirement practice leader for the Marsh McLennan Agency, a workplace benefits company. “Part of this is still a result of the Covid pandemic. A lot of it is inflation – just the grind of daily life.”
Mark Scharf, an information technology worker in New York City, has taken money out of retirement accounts three times since the 2008 recession. He has withdrawn more than $50,000 to pay off credit card debt, tuition for his six children a religious school and, most recently, an overdue mortgage.
“It really was a choice of saving the present versus securing the future,” he said. “My situation was not that of someone frivolous. Expenses were just more than I was earning.
Now working in the public sector and paying a pension, Scharf, 55, reckons that if he retires at 70, he will be able to withdraw 40% of his old salary. As much as his retirement accounts worked as breakers to reset his debts, he is relieved that he doesn’t have the option to withdraw his pension contributions.
“I don’t want to do this anymore, so I’m forcing myself not to,” he said.
Mr. Scharf has a lot of company, especially recently. Two major retirement plan managers, Fidelity and Vanguard, have seen increases in hardship withdrawals, which can only be taken if there is “immediate and dire financial need,” according to the Internal Revenue Service. Fidelity found that 2.4% of the 22 million people with retirement accounts in its system made hardship withdrawals in the last quarter of 2022, up half a percentage point from the previous year. A similar Vanguard analysis found that 2.8 percent of five million people with retirement accounts made a hardship withdrawal 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 making hardship withdrawals increased by 33% over the same period a year earlier, with workers withdrawing an average of $5,100 each.
“Customers are much more aware that their retirement accounts are not sacrosanct,” said Steve Parrish, 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% in April 2020 because of Covid lockdowns and stimulus payments, it has now dropped to around 5%, according to the US Bureau of Economic Analysis.
“What this increase in general hardship withdrawals indicates is that, in general, people 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 up, people may have to look at their retirement account,” she said.
Also, people often have to withdraw more money than they need to to cover federal income tax and a 10% early withdrawal penalty if they don’t qualify for an exemption. Exemptions can be granted for a limited number of circumstances, such as death or permanent disability.
“The cost of living is definitely pushing customers to the limit right now,” said Sarah Honsinger, credit counselor at Apprisen, a nonprofit debt management organization.
Mrs. Honsinger added that the CARES Act, which temporarily relaxed restrictions on hardship withdrawals in 2020, had triggered an increase in retirement account withdrawals.
Lawrence Delva-Gonzalez, who runs a personal finance blog called Neighborhood Finance Guy, said he has watched people in the Haitian-American community of Miami, his hometown, go down the rabbit hole during the worst of Covid, without a clear long-term vision. repercussions of the term.
“When it came to the pandemic and the word got out that you could withdraw the money early without a penalty, they did it,” he said.
Delva-Gonzalez said he worried that a lack of financial literacy would endanger marginalized workers like themselves. “My community has almost no access to this,” he said.
Without retirement money, these workers face a bleak future.
“People who are approaching 64, 65 have basically run out of options,” he said. “They don’t have any savings and they have debt to retire on.”
Delva-Gonzalez, 40, said the repercussions could spill over to the next generation, pointing to her own family as an example.
“My wife and I already know that we’re probably going to be the people who support my mom, her mom, and her dad,” he said, an expense he estimated to cost several thousand dollars a month. “There is very little you can do before you start cutting into your own retirement, your own lifestyle and your ability to start a family.”
Greater access to plans, and money
The Secure 2.0 Act, passed by Congress last year, aims to increase workers’ access to retirement benefits, notably by making it easier for companies to offer 401(k) plans. It also cuts down on the amount of paperwork workers face when withdrawing money from a retirement account, and expands the list of circumstances for waiving the 10% penalty applied to money withdrawn if the owner is 59 1/2 or younger.
Retirement experts see the legislation as a double-edged sword.
“It’s wonderful to see Congress do something to get more employers to offer qualifying plans,” said Parrish of the American College of Financial Services. “It’s worrying on the consumer side that maybe it’s a little too easy to get. Great, you can get your money – but you only retire once.
Taking money out of a retirement account has an outsized effect on a person’s future financial security because those funds are no longer invested and the returns compound. Even people who consider themselves financially savvy admit that fully understanding the effect on a nest egg can be difficult when retirement is decades away.
Common advice for 401(k) owners thinking about withdrawing money is to take out a loan against the account. But, as Ashley Patrick discovered, even these loans can backfire. A decade ago, she and her husband borrowed $24,000 from their 401(k) to renovate their home near Charlotte, NC, but their payment plans were derailed when he was laid off.
Borrowers get a five-year repayment term – as long as they remain with their employer. But if they lose or leave their job, the borrower will have to pay off the loan by next year’s tax deadline. If they miss that deadline, the IRS treats the distribution as a withdrawal and applies taxes and penalties.
“We didn’t have any money,” said Patrick, 38. “It’s been spent.”
The following April, the couple faced a $6,000 tax bill. But the biggest loss was the lost opportunity to keep the money invested, Patrick said.
“We were 20 years old when we did this, so it would take a long time to grow and have this compost,” she said. “I didn’t think about the long-term cost until I started learning more about finance.”
The 401(k) as a substitute for savings
Retirement planning experts say one of the reasons there are more withdrawals today is that more workers have 401(k)s, including low-income and historically disadvantaged workers, who are more likely to rely on their retirement savings as a fund. of emergency.
“The increase we’ve seen highlights and underscores the importance of an emergency savings account as a first line of defense,” said Fiona Greig, global head of research and investor policy at Vanguard. “Historically, we’ve shown that those who make hardship withdrawals tend to be low-income workers.”
Mrs. Greig said one of the reasons people use their savings for retirement is to avoid evictions or foreclosures. “I’m starting to wonder if there are more problems coming up with low-income families,” she said.
Low-income workers especially need the financial security offered by a 401(k) in retirement because they receive lower Social Security benefits and are more likely to hold physically strenuous jobs that become more difficult to perform with age.
One possible solution, say some experts, is to allow employers to set up emergency savings accounts for employees linked to their 401(k) accounts. The Secure 2.0 Act includes a clause that would allow retirement plan sponsors to create these so-called secondary accounts starting in 2024. be withdrawn without triggering a penalty.
Sid Pailla, chief executive of Sunny Day Fund, a financial technology company that helps workers set up emergency funds, said this move would be a boon for low-income workers who might otherwise be able to withdraw emergency funds. of your 401(k).
Pailla, 35, said he can relate to that kind of financial stress.
“My experience with that came pretty early in my life in America,” he said.
Not long after his family immigrated from India, Pailla vividly recalled, he guided his parents, who spoke little English, through the Byzantine 401(k) early withdrawal process when they both lost their jobs after the dot-com crash of the 1990s. .
“I was about 12 years old,” he said. “I was definitely scarred by it.”