More Americans are looting their retirement accounts as the cost of living rises, and experts predict the number of workers turning to their 401(k)s to pay for financial emergencies it may rise due to a confluence of factors, including new provisions making it easier to withdraw and high inflation that is straining household budgets.
“It’s more expensive to live these days, and that’s what’s hitting participants,” said Craig Reid, national retirement practice leader at Marsh McLennan Agency, a workplace benefits company. “Some of this is still a spillover from 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Mark Scharf, an information technology worker in New York City, has withdrawn money from retirement accounts three times since the 2008 recession. He withdrew 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 of saving the present versus securing the future,” he said. “My situation was not that of someone frivolous. The expenses were simply more than what he earned.”
Now working in the public sector and paying a pension, Scharf, 55, estimates that if he retires at 70, he can receive 40 percent of his previous salary. Although his retirement accounts have functioned as circuit breakers to reset his debt, he is relieved that he does not have the option to withdraw his pension contributions.
“I don’t want to have to do that anymore, so I force myself not to do it,” she said.
Mr. Scharf has a lot of company, especially recently. Two large retirement plan administrators, Fidelity and Vanguard, have seen increases in hardship withdrawals, which can be taken only if there are “an immediate and heavy 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 made hardship withdrawals in the last quarter of 2022, up half a percentage point from the previous year. A similar analysis by Vanguard found that 2.8 percent of the five million people with retirement accounts made a hardship withdrawal last year, up from 2.1 percent the year before.
In the first three months of 2023, Bank of America found that the number of people taking hardship withdrawals increased 33 percent over the same period a year earlier, with workers taking out an average of $5,100 each.
“Clients are much more aware that their retirement accounts are not sacrosanct,” said Steve Parrish, an adjunct professor and co-director of the American College of Financial Services’ Retirement Income Center. “The trend has already started. People are realizing that their 401(k) isn’t locked in until they turn 60.”
Some experts warn that this could be just the tip of the iceberg, as it targets the many American families struggling with higher costs. Although 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 percentaccording to the US Bureau of Economic Analysis.
“What this increase in hardship withdrawals indicates overall is that people generally don’t have enough savings in the short term,” said Kirsten Hunter Peterson, vice president of thought leadership for workplace investing at Fidelity. . “When that unavoidable unexpected expense comes up, people may have to look into their retirement account,” she said.
In addition, people often have to withdraw more money than they need to cover federal income tax and a 10 percent 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 clients over the edge right now,” said Sarah Honsinger, a credit counselor at Apprisen, a nonprofit debt management organization.
Ms. Honsinger added that the CARES Act, which temporarily relaxed restrictions on hardship withdrawals in 2020, led to an increase in withdrawals from retirement accounts.
Lawrence Delva-Gonzalez, who runs a personal finance blog called the neighborhood finance guyHe said he has watched people in the Haitian-American community of Miami, his hometown, dip into their savings during the worst of Covid with no clear vision of the long-term repercussions.
“When it came to the pandemic and word got out that you could withdraw the money earlier without penalty, they did it,” he said.
Mr. Delva-González said he was concerned that a lack of financial education would endanger marginalized workers like them. “My community has almost no access to it,” he said.
Without their retirement money, these workers face a bleak future.
“People who are getting to 64, 65 have basically run out of options,” he said. “They don’t have savings and they have debts before they retire.”
Delva-González, 40, said the repercussions can spill over to the next generation, pointing to her own family as an example.
“My wife and I already know that we are probably going to be the people who will support my mom and her mom and dad,” he said, an expense he estimated would cost several thousand dollars a month. “There’s a lot she can do before she starts cutting back on her own retirement and her own lifestyle and her ability to raise 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, primarily by making it easier for companies to offer 401(k) plans. It also reduces the amount of red tape workers face when withdrawing money from a retirement account and expands the list of circumstances to waive the 10 percent penalty applied to money withdrawn if the owner is age 59 1/2 or younger.
Retirement experts view the legislation as a double-edged sword.
“It’s great to see Congress do something to get more employers to offer qualified plans,” said Mr. Parrish of the American College of Financial Services. “On the consumer side, it is concerning that it may be too easy to reach. Great, you can take advantage of your money, but you only retire once.”
Taking money out of a retirement account has a huge effect on a person’s future financial security, because those funds are no longer invested and generate returns that compound. Even people who consider themselves financially savvy admit that fully understanding the effect on savings can be difficult when retirement is decades away.
A common piece of advice for 401(k) owners who are thinking of withdrawing money is to borrow against the account. But as Ashley Patrick discovered, even those loans can backfire. A decade ago, she and her husband borrowed $24,000 from his 401(k) to renovate her home near Charlotte, NC, but her payment plans went off the rails 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 quit their job, the borrower has to repay the loan before next year’s tax filing deadline. If they do not meet 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’s already spent.”
The next April, the couple faced a $6,000 tax bill. But the biggest loss was the missed opportunity to keep that money invested, Patrick said.
“We were 20 years old when we did this, so he would have had plenty of time to grow up and have that compound,” he 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 reason 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 401(k)s. retirement savings as an emergency fund.
“The rally we’ve seen highlights and underscores the importance of an emergency savings account as a first line of defense,” said Fiona Greig, global director of investor research and policy at Vanguard. “Historically, we have shown that those making hardship withdrawals tend to be low-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 angst is coming up in low-income households,” she said.
Low-income workers have a special need for the financial security that a 401(k) offers in retirement because they get lower Social Security benefits and are more likely to do physically demanding jobs that become more difficult with age. .
One possible solution, some experts say, is to allow employers to set up emergency savings accounts for employees that are linked to their 401(k) accounts. The Secure 2.0 Act includes a provision that would allow retirement plan sponsors to set up these so-called sidecar accounts beginning in 2024. Workers could contribute their after-tax earnings a little at a time, up to a maximum of $2,500, and those funds could be removed without giving rise to a penalty.
Sid Pailla, chief executive of the Sunny Day Fund, a fintech company that helps workers set up emergency funds, said this change would be a boon for low-income workers who might otherwise be able to draw funds from emergency from your 401(k).
Mr Pailla, 35, said he could relate to that kind of financial stress.
“My experience with him came quite early in my life in the United States,” he said.
Not long after his family immigrated from India, Mr. Pailla vividly recalled, he guided his parents, who spoke little English, through the byzantine process of withdrawing early from 401(k)s when they both lost their jobs after the dotcom crash in the 1990s.
“I was about 12 years old,” he said. “He was definitely scarred by that.”