Financial Distress Fuels Rise In 401(k) Hardship Withdrawals

A recent report from Bank of America
BAC
found that a growing number of Americans are resorting to hardship withdrawals from their 401(k) accounts, signaling financial distress is on the rise. Hardship withdrawals refer to funds withdrawn from an individual’s 401(k) account due to immediate and heavy financial need. Federal law states these withdrawals are taxed and cannot be repaid into the account.

The second quarter of 2023 saw a surge in the number of people resorting to hardship withdrawals. This increase is 36% higher than the same period the previous year, according to data from Bank of America.

In addition to hardship withdrawals, the data shows an increase in the number of participants borrowing from their workplace plans. However, overall employee contributions remained steady in the first half of the year.

The Impact Of Economic Factors

The global pandemic, followed by two years of high inflation, has clearly impacted the financial stability of households. Since 2019, household debt balances have increased by nearly $3 trillion, reports CNN. The New York Fed reported that U.S. households’ credit card debt surpassed the $1 trillion mark for the first time in the second quarter of 2023.

However, it’s not just about the increasing debt. It’s about the delicate financial balance many people are maintaining. A medical emergency, job loss, or even the restart of student loan payments, which went into effect this month, could tip many into financial distress.

The State Of 401(k) Balances

Despite the increasing number of withdrawals, a Fidelity report found that retirement account balances have shown a positive trend in the first half of the year, thanks to improved market conditions. However, this doesn’t negate the fact that more people are prioritizing short-term expenses over long-term savings. This is understandable, considering the immediate financial challenges many face. But the long-term implications could be concerning.

he Fidelity report shows the average 401(k) balance has increased by 8% from a year ago to $112,400. This is the third consecutive quarter of increase. The average individual retirement account balance has also increased, reaching $113,800 in the second quarter of 2023.

However, increasing balances don’t necessarily mean financial security. The percentage of participants with a loan outstanding also increased. And the share who took out hardship withdrawals reached 1.7% in the latest quarter.

Financial Strain And Its Indications

The increase in withdrawals and loans is indicative of the financial strain many households are experiencing. It’s a troubling sign, especially considering the unemployment rate remains low at 3.8%, according to the latest U.S. jobs report.

The data presents two diverging narratives. On the one hand, there’s balance growth, optimism from younger employees, and maintained contributions. On the other hand, there’s a trend of increased plan withdrawals.

Alongside declining personal savings rates, record-high credit card debt, and more than 50% of American adults living paycheck to paycheck, as reported by Bankrate, it’s clear that there are still significant financial challenges ahead.

While hardship withdrawals can provide temporary relief in a crisis, they should be a last resort. The long-term implications on retirement savings can be severe.

Financial experts advise exploring other options first, such as home equity lines of credit or liquidating other assets.

The rise in 401(k) hardship withdrawals is a clear call for comprehensive financial planning and education. With proper guidance and support, individuals can navigate their financial challenges without compromising their future financial stability.

Brian Menickella is the founder and managing partner at Beacon Financial Services, a broad-based financial advisory firm based in Wayne, PA.

Securities and Advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.

This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice.