It’s no secret that saving for retirement has taken a backseat for many Americans due to a plethora of reasons. Inflation, resumption of student loans and soaring rates have all taken a toll on wallets.
In turn, this has translated into an increase of so-called “hardship withdrawals.” Simultaneously, 401(k) balances have been dwindling, according to Fidelity.
For instance, in the third quarter of 2023, the average 401(k) balance decreased to $107,700, down 4% from the second quarter, per Fidelity. Meanwhile, the average IRA balance followed a similar trajectory, decreasing 4% in the third quarter to $109,600.
At the same time, hardship withdrawals have been increasing, with 2.3% of workers taking them in the third quarter — up from 1.8% in the same quarter in 2022.
“The top two reasons behind this uptick were avoiding foreclosure/eviction and medical expenses,” said Michael Shamrell, VP of thought leadership for Fidelity‘s Workplace Investing.
The Nature of Hardship Withdrawals
Certain retirement plans allow participants to receive so-called hardship withdrawals, or distributions — but they can only be made if the distribution is both due to an immediate and heavy financial need, and limited to the amount necessary to satisfy that financial need, the Internal Revenue Service (IRS) explained on its website.
These include expenses for medical care, costs related to the purchase of a principal residence, payment of tuition, payments necessary to prevent an eviction and payments for funeral expenses.
However, there are also consequences, as you may also have to pay an additional 10% tax — unless you’re age 59½ or older or qualify for another exception. Also, you may not be able to contribute to your account for six months after you receive the hardship distribution, according to the IRS.
“This increase in withdrawals and loans shows the impact economic events such as inflation and market volatility can have on Americans’ wallets — and ultimately their retirement savings — and underscores the need for Americans to build up their emergency savings,” added Shamrell.
Shamrell indicated that 56% of employees say they would feel a little, or completely, overwhelmed if an unexpected financial challenge came up, such as a medical issue.
Why Is This Concerning?
According to Bobbi Rebell, CFP and founder of Financial Wellness Strategies, a drop in 401(k) balances in the third quarter tied to market conditions should be put in perspective.
“Market volatility is part of investing,” she said.
However, what’s actually concerning is the increase in hardship withdrawals, she added.
“The reasons point to the continued lack of affordability in the housing market, including higher mortgage payments due to higher interest rates, as well as the continued high costs of medical care. These are systemic issues that are troubling,” added Rebell.
And as Jay Zigmont, PhD, MBA, CFP and founder of Childfree Wealth noted, the problem with a hardship withdrawal is that it may not only produce a heavy cost in taxes and penalties, but is also stealing from the future.
“It becomes a game of trying to figure out if you need the money more now or in the future. Any money you take out through a hardship withdrawal cannot be put back, and will not be growing between now and retirement,” he said.
Why Taking Hardship Withdrawals Can Be Detrimental to Financial Health
Unexpected expenses can derail budgets, short-term financial goals, and even progress saving for retirement if employees don’t have short-term savings available, according to Fidelity’s Shamrell.
“In fact, employees who lack emergency savings are more likely to withdraw money from their retirement accounts (such as a 401(k)) to cover expenses, as it may be the only source of savings they have,” he said.
He noted, however, that withdrawing from your retirement should be viewed as a last resort, since it often comes with penalties in the way of taxes and fees.
To avoid turning to retirement savings to cover a short-term or unexpected expense, if at all possible, it is important for individuals to consider building up a small nest egg of emergency savings.
“To help tackle this problem, many employers are adding workplace benefits programs focus on emergency savings to their benefits rosters,” he said. “In addition, when it comes to retirement, remember to take a long-term approach to retirement savings, and not make changes based on short-term market events.”
