Early withdrawals from retirement accounts have become increasingly common as workers strive to cope with financial stress, according to data from Fidelity Investments in the third quarter.
Increased Hardship Withdrawals
While the Internal Revenue Service imposes penalties on early withdrawals from tax-advantaged accounts like 401(k) plans, there is some flexibility for withdrawals in specific circumstances involving "immediate and heavy financial need." In the third quarter, the share of plan participants taking these hardship withdrawals rose to 2.3% from the same period last year, representing a 28% increase. Although this percentage remains relatively low, it signals that prolonged inflation is taking its toll on household finances.
Key Reasons for Withdrawal
Fidelity plan participants cited two primary reasons for tapping into their retirement accounts: avoiding foreclosure or eviction and covering medical expenses. These pressing concerns prompt individuals to take the step of withdrawing money early.
Rise in 401(k) Loans
In addition to hardship withdrawals, loans from 401(k) plans are also seeing an upward trend. Fidelity discovered that in the third quarter, 2.8% of participants took out loans from their 401(k), compared to 2.4% during the same period in 2022. The percentage of workers with outstanding 401(k) loans increased from 16.8% to 17.6% over the course of the year.
Taxation and Repayment
Unlike hardship withdrawals, which are subject to taxation and are not repaid, loans from retirement accounts must be repaid. However, if participants adhere to the rules and repayment schedules, these loans are not taxed.
In conclusion, the data provided by Fidelity Investments reveals an upward trend in early retirement account withdrawals and loans. This indicates that financial stress, particularly driven by concerns like foreclosure/eviction and medical expenses, is a significant factor influencing workers' decisions to tap into their retirement funds. While there are penalties and tax implications associated with early withdrawals, the flexibility provided by hardship rules and repayment options for loans allow individuals to address immediate and pressing financial needs.
Retirement Accounts and the Importance of Emergency Savings
The increasing trend of using retirement accounts as emergency funds highlights the necessity for workers to have separate savings for unexpected situations, as reported by Fidelity. Their research shows that after retirement savings, workers prioritize emergency savings as their top financial goal.
Last year, the Secure 2.0 Act introduced an important provision allowing the creation of in-plan emergency savings accounts. Starting in the upcoming year, employers will have the choice to include a pension-linked emergency savings account, also known as a PLESA, in their retirement-plan offerings.
Under these accounts, employees can contribute up to $2,500 annually on a post-tax basis, with this limit adjusted for inflation. In cases where employers match contributions to their employees' 401(k) accounts, they will also be required to match contributions to PLESA. It's worth noting that PLESA contributions are included within the annual 401(k) contribution limit. For the year 2024, this limit is set at $23,000 for individuals under 50 years old and $30,500 for those aged 50 and over.
Despite the rise in hardship withdrawals and loans, Fidelity's findings reveal that most retirement savers remained committed to their savings goals during the third quarter. Among Fidelity plan participants, the total savings rate for the period stood at a commendable 13.9%, taking into account both employee and employer contributions. While slightly below the recommended rate of 15%, this demonstrates a continued dedication to building retirement funds.
