Financial Distress Leads To Surge In Early 401(k) Withdrawals, Bank Report Shows

A growing number of Americans are resorting to hardship withdrawals from their 401(k) accounts, a recent Bank of America report found. This signals that financial distress is on the rise.

Hardship withdrawals refer to times when people take out funds from their 401(k) accounts due to immediate and heavy financial need. Federal law states these withdrawals are taxed and cannot be repaid into an account.

In the second quarter of 2023, there was a surge in the number of Bank of America plan holders (15,950) resorting to hardship withdrawals. This figure is 36% higher than Q2 of 2022, according to data from the bank.

In addition to hardship withdrawals, the data shows an increase in the number of participants borrowing from their workplace plans — from 56,000 in Q1 of 2023 to 75,000 in Q2. However, overall employee contributions remained steady in the first half of the year.

The Impact Of Economic Factors

The Covid-19 pandemic, followed by two years of high inflation, has 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 people face. But the long-term implications could be concerning.

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

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

The Indications Of Financial Strain

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 September 2023 U.S. jobs report.

The data presents two diverging narratives. On the one hand, there’s growth in balances, optimism from younger employees, and maintained contributions. On the other hand, there’s a sign 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, 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.