More retirement savers are prematurely withdrawing money from their 401(k) accounts, as the price of everyday goods and services remains inflated, The New York Times reports.
Most troubling, say retirement savings experts, is Americans’ perception of their 401(k) accounts has changed from one of protecting their future to one of taking care of immediate needs.
“Customers are much more aware that their retirement accounts are not sacrosanct,” says 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 their 401(k)s aren’t locked until they’re 60.”
Some fear this is just the start of a new trend of people raiding their 401(k)s, individual retirement savings accounts (IRAs) or other long-term accounts. The personal savings rate hit a high of 34% in April 2020 during the COVID lockdowns and stimulus payments—but is now a mere 5%, according to the U.S. Bureau of Economic Analysis.
“It’s just more expensive to live these days, and that’s what’s putting the pinch on participants,” says Craig Reid, national retirement practice leader at Marsh McLennan Agency, a workplace benefits and consulting company. “Some of it is still spillover from the COVID pandemic. A lot of it is inflation—just the grind of daily life.”
Besides the need to cover bills, a big reason why people are now taking out loans and even hardship withdrawals from their 401(k)s is that legislation passed during COVID made it easier for them to do so. The CARES Act temporarily relaxed restrictions on withdrawals in 2020, notes Sarah Honsinger, a credit counselor with Apprisen, a nonprofit that helps people manage debt.
“The cost of living is definitely tipping clients over the edge at this point,” Honsinger says.
Indeed, in the first quarter of 2023, hardship withdrawals from Bank of America retirement accounts surged 34% from a year earlier to an average of $5,100 apiece.
Mark Scharf, a information technology worker in New York, has taken $50,000 from his retirement accounts three times since the Great Recession of 2008 to pay overdue credit card bills, parochial school tuition for his six children and, recently, an overdue mortgage.
“It was really a choice of saving the present versus securing the future,” Scharf says. “My situation wasn’t someone who’s frivolous. Expenses were just more than I was making.”
Financial planners strongly advise against withdrawing money from a retirement account and say it should only be a last resort option. Besides lessening the chances for an adequate standard of living in retirement as measured by the dollar amount taken from an account, there’s taxes plus an early withdrawal penalty of 10% for those younger than 59-1/2.
There is also the lost opportunity cost of money not being invested and, therefore not compounding, in a retirement account.
Hardship withdrawals do not have to be repaid to a 401(k) account but loans must be repaid. Companies typically require the loans to be repaid within five years, and if an employee leaves or is terminated, the loan typically must be repaid by the following year’s tax deadline. Most people can’t repay 401(k) loans of high sums, so the IRS considers the loans to be withdrawals and presents borrowers with tax bills and penalties.
Ashley Patrick learned about the unforeseen downsides to taking out a loan firsthand. A decade ago, she and her husband borrowed $24,000 from his 401(k) to renovate their home outside Charlotte, N.C.
Patrick’s husband was suddenly laid off, and the couple found themselves unable to pay back the funds.
“We didn’t have the money,” Patrick, now 38, says. “It was already spent. We were in our 20s when we did this, so it would have had a very long time to grow and have that compound. I didn’t think about the long-term cost until I started learning more about finances.”
This is why major retirement savings companies, like Fidelity Investments and Vanguard, recommend companies help their workers set up systematic emergency savings accounts alongside their 401(k)s. The Secure 2.0 Act permits companies to set up these types of workplace-sponsored emergency savings accounts up to a total of $2,500.
Such sidecar accounts, as they are sometimes called, are “a first line of defense,” says Fiona Greig, global head of investor research and policy at Vanguard.
Greig also fears more workers will raid their 401(k)s. “I’m starting to wonder whether there’s more distress emerging with lower-income households,” Grieg says.
The Sunny Day Fund is one fintech company that helps employers set up emergency savings accounts. Its CEO, Sid Pailla, said he witnessed firsthand the financial fallout of taking money early from a retirement savings account when his parents, Indian immigrants, both lost their jobs in the dot-com crash and raided their 401(k)s.
Just 12 at the time, Pailla says witnessing his parents’ financial worries “definitely scarred” him, motivating him to do better for himself and to help others with retirement savings and budgeting, as well.
Read Newsmax: Inflation Prompts Americans to Tap Their 401(k)s | Newsmax.com
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