Higher Cost of Living Spurs Workers to Utilize 401(k) Savings as Support

Although experts caution that withdrawals from 401(k) funds can have a negative impact on long-term financial security, retirement plan administrators have noticed a noticeable increase in hardship withdrawals. As the cost of living continues to rise, more Americans are resorting to utilizing their retirement savings to address financial emergencies. Several factors contribute to this trend, including new provisions that facilitate withdrawals and high inflation, which strains household budgets.

Craig Reid, the national retirement practice leader at Marsh McLennan Agency, emphasizes that living expenses have become increasingly burdensome, affecting participants’ financial well-being. He attributes this phenomenon to the residual effects of the Covid-19 pandemic and the relentless pressure of daily life, compounded by inflation.

One example is Mark Scharf, an information technology worker in New York City, who has withdrawn funds from his retirement accounts on three separate occasions since the 2008 recession. He utilized the money to pay off credit card debts, cover tuition expenses for his six children attending a religious school, and address an overdue mortgage. Scharf explains that it was a choice between addressing immediate needs or securing his future, as his expenses exceeded his income.

During the first quarter of 2023, Bank of America reported a 33 percent increase in the number of people resorting to hardship withdrawals compared to the same period the previous year, with an average withdrawal amount of $5,100 per worker.

Also read: The difficulty of accessing your savings in an emergency

Steve Parrish, adjunct professor and co-director of the Center for Retirement Income at the American College of Financial Services, points out that customers are becoming more aware that their retirement accounts are not inviolable. This awareness contributes to the growing trend of tapping into 401(k) savings before reaching the age of 60.

Experts express concern that this trend may represent only the beginning, with numerous American families grappling with elevated costs. Although personal savings rates spiked to nearly 34 percent in April 2020 due to Covid-19 lockdowns and stimulus payments, the rate has since fallen to approximately 5 percent, according to the U.S. Bureau of Economic Analysis. Kirsten Hunter Peterson, vice president of thought leadership for workplace investing at Fidelity, explains that the increase in hardship withdrawals reflects a broader issue: inadequate short-term savings. Consequently, when unexpected expenses arise, individuals may be forced to turn to their retirement accounts for financial relief.

Moreover, individuals often end up withdrawing more funds than necessary due to federal income tax requirements and a 10 percent early withdrawal penalty, unless they qualify for a waiver. Limited waivers are granted in specific circumstances, such as death or permanent disability.

Also read: Ensuring Transparency: Hidden Terms and Conditions of Savings Accounts

Sarah Honsinger, a credit counselor at Apprisen, a nonprofit debt management organization, confirms that the rising cost of living is pushing many clients to their limits. However, withdrawing money from a retirement account substantially impacts future financial security since those funds are no longer invested and generate compounded returns. Even financially knowledgeable individuals find it challenging to fully comprehend the long-term implications of depleting their nest egg when retirement is decades away.

While taking out a loan against a 401(k) account is often recommended instead of outright withdrawals, risks are involved. Ashley Patrick’s experience serves as an example. She and her husband borrowed $24,000 from his 401(k) to renovate their home, but repayment plans were disrupted when he lost his job. Borrowers have a five-year repayment term as long as they remain employed. However, if they become unemployed or quit, they must repay the loan by the next year’s tax filing deadline. Failure to meet this deadline leads to the Internal Revenue Service treating the remaining loan balance as a withdrawal, subjecting it to taxes and penalties.

The article concludes by highlighting the adverse financial consequences of cashing out a 401(k), such as tax liabilities, penalties, lost employer matches, and the missed opportunity for long-term compounding. It urges individuals leaving their jobs to seek guidance from financial advisors, explore options for rollovers into IRAs, or consider transferring the funds to a new employer’s 401(k) plan to safeguard their retirement savings.

Also Read: Understanding the Reasons for the Decreasing Savings Account Interest Rates