401(k) 'hardship' withdrawals hit record high, Vanguard says — another sign households are feeling the pinch of inflation

401(k) ‘hardship’ withdrawals hit record high, Vanguard says — another sign households are feeling the pinch of inflation

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The share of retirement savers who withdrew money from a 401(k) plan to cover financial hardship hit a record high in October, according to data from the Vanguard Group.

This dynamic – when combined with other factors such as rapidly rising credit card balances and falling personal savings rates – suggests that households are finding it harder to make ends meet in a high inflation and need liquidity, according to financial experts.

Nearly 0.5% of workers participating in a 401(k) plan took a new “hardship allocation” in October, according to Vanguard, which tracks 5 million savers. This is the largest share since Vanguard started tracking data in 2004.

In other words, about 25,000 workers took one of these distributions, which allow workers to tap into their pre-retirement 401(k) plans for “immediate and heavy” financial need.

Meanwhile, savers have been tapping into their nest eggs in other ways — “non-hard” loans and distributions — in greater numbers throughout 2022, Vanguard data shows.

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“We’re starting to see signs of financial distress at the household level,” said Fiona Greig, global head of research and investor policy at Vanguard.

That said, the overall monthly share of people taking a hardship withdrawal is relatively small and not indicative of the “typical” 401(k) saver, she added.

Americans ‘feel the pinch of inflation’

Almost all 401(k) plans allow workers to take hardship withdrawals, but employers may vary in their rationale for allowing them.

According to the Plan Sponsor Council of America, a trade group, more than half of plans allow workers to tap into funds to “ease major financial pressures.” But they more frequently allow deductions to cover medical expenses, housing (to buy a main residence, or avoid eviction or foreclosure), funeral expenses or losses due to natural disasters, for example.

Participants can also access 401(k) savings through hassle-free loans or withdrawals. The latter are intended for workers over the age of 59.5, and sometimes for workers in other circumstances not related to financial hardship (for example, transferring assets to an individual retirement account while working).

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Non-difficult distributions also hit an all-time high in October — nearly 0.9% of participants took one that month, according to Vanguard. And the share of workers taking out 401(k) loans rose to 0.9% in October, from 0.8% at the start of 2022.

Overall, this is a sign that more households need cash.

“People are feeling the pinch of inflation,” said Philip Chao, director and chief investment officer at Experiential Wealth in Cabin John, Maryland.

Savers aren’t always careful in their financial decisions and often think of a 401(k) “more like a piggy bank,” he said.

The inflation rate has come down in recent months from its pandemic-era peak this summer, but is still near its highest level since the early 1980s. The prices consumers pay for a wide range of goods and services – like groceries and rent – continue to rise rapidly. Wage growth has not kept pace with the average person.

Meanwhile, federal financial supports in the pandemic era have dwindled. A pause in student loan payments – among the last vestiges of support – could end next year. Many households have spent at least some of the accumulated savings from stimulus checks and improved unemployment benefits. The personal savings rate of 2.3% in October was a pandemic-era low. Household debt soared at its fastest pace in 15 years in the third quarter. Delinquencies in the third quarter increased for almost all types of household debt, although they remain low by historical standards, according to the Federal Reserve Bank of New York.

In 2020, Congress authorized Covid-related withdrawals of up to $100,000 from 401(k) plans under the CARES Act. About 1% of participants made such withdrawals each month in 2020, and other types of withdrawals decreased slightly during this period.

Why plundering retirement savings is a ‘terrible idea’

“It’s a really bad idea to withdraw money from your 401(k),” said Ted Jenkin, certified financial planner and co-founder of Atlanta-based oXYGen Financial.

The recent increase in hardship distributions is of particular concern, financial advisers said. Beyond the apparent acute financial need of households, hardship withdrawals have negative repercussions.

For example, workers under age 59.5 generally owe a 10% penalty tax on their withdrawal, in addition to income tax on pre-tax savings. This is also true for non-difficult withdrawals and defaulted loans.

But, unlike a 401(k) loan, savers can’t pay themselves off when they take a hardship distribution — meaning the savings and its future investment earnings are permanently lost, unless the workers cannot somehow compensate later with higher savings rates. And many employers prohibit workers from contributing to their 401(k) for six months after taking a hardship distribution.

Why Americans have a harder time retiring

There was an uptick in hardship distributions after Congress passed the 2018 Bipartisan Budget Act, which eased access, Greig said. The law removed the requirement that participants first have to take out a 401(k) loan before they could make a hardship withdrawal.

Households should weigh all their money options before resorting to a 401(k) plan, said CNBC advisory board member Jenkin.

For example, households without an emergency fund might be able to free up cash for relatively small short-term cash flow needs by canceling or reducing membership plans, or selling little-used or unnecessary items. on Facebook Marketplace or a garage sale, he said. . A short-term loan or home equity line of credit would generally also be preferable to a 401(k).

We are starting to see signs of financial distress at the household level.

Fiona Greig

Global Head of Investor Research and Policy at Vanguard Group

Selling investments in a taxable investment account may also be a better option than plundering a retirement account or going into debt, Greig said. While the stock market is down this year, investors may still be in the dark looking at the past two or three years, she said. However, they will have to pay capital gains tax if they sell winning investments; even if they sell these investments at a loss, they can use these losses to gain a tax advantage through tax loss harvesting.

Consumers should also look at the root cause of their financial need, especially if it’s not due to a one-time, unexpected need, Jenkin said.

“Taking a hardship withdrawal is an effect,” Jenkin said. “It’s the end product of needing money today.

“As a business, you have to ask yourself, do I have a revenue problem, an expense problem, or both?”

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