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Tags: 401k loans | hardship withdrawals | retirement savings

More 401(k)s Do Double Duty as Emergency Funds

More 401(k)s Do Double Duty as Emergency Funds
(Dreamstime)

By    |   Thursday, 02 February 2023 10:54 AM EST

Cash-strapped Americans are tapping into their 401(k)s like never before, some even selecting the option that permits up to a $100,000 withdrawal.

A record 2.8% of Vanguard's five million 401(k) plan participants took a hardship withdrawal from their savings in 2022 for such emergencies as a medical bill, foreclosure or eviction, The Wall Street Journal reports. That is up from an average of 2% before COVID hit and 2.1% in 2021.

More people are taking a 401(k) hardship withdrawal not just because of the current economic environment of layoffs, inflation, higher credit card debt and lower savings — but because of a 2018 rule loosening the rules. That was followed by yet more leniencies in 2020 spurred by COVID-19.

The 2018 law permitted 401(k) borrowers to sidestep the more restrictive rules of 401(k) loans to go straight to hardship withdrawals. Loans, on the other hand, are capped at half of a person’s 401(k) balance up to a maximum of $50,000 and must be repaid. Loans also impose taxes and a 10% penalty for those younger than 59-1/2.

The 2018 law also let people taking out hardship withdrawals to access not just their contributions but earnings from their investments.

More Hands in the Till

On top of that, a COVID-era law let those impacted by the pandemic take out as much as $100,000 in a hardship withdrawal without the burden of the 10% early withdrawal penalty. When that law was passed in 2020, 5.7% of eligible Vanguard participants took out a hardship withdrawal.

The average hardship withdrawal rose to $7,000 in 2022, up from $5,500 the year before.

Furthermore, on top of all of these easements, in December, Congress passed a law no longer requiring hardship withdrawal applicants to show proof of duress, such as an eviction notice.

Up until that time, hardship withdrawals could also be used for a down payment on a primary home, college tuition and emergency home repairs. The December amendment expanded that to include terminal illness, domestic abuse and withdrawals up to $22,000 for those impacted by federally declared disasters.

A 401(k) Piggy Bank

In short, the laws cumulatively have expanded people’s 401(k) savings to become a backstop emergency fund.

With $20 trillion in 401(k) plans, there certainly is a lot of money for the taking.

“There’s an understanding that for a lot of people, this is the only pot of money they have,” says Rob Austin, director of research at 401(k) provider Alight Solutions.

The more lenient 401(k) accessibility rules come at a time when there is a movement at companies to help people set up emergency funds alongside their 401(k)s. As COVID erupted in the United States and millions of people found themselves suddenly without jobs, their lack of emergency savings became woefully apparent.

In addition, automatic enrollment into 401(k) plans is more of the norm not just at Fortune 500 companies but also medium-sized companies of 100 people or less — and participants in these plans want ready access to their money.

Financial advisers wholeheartedly agree that 401(k) savings should be used only for retirement and that people should only take out a loan or hardship withdrawal as a last resort.

If a person absolutely must get hold of some money, a loan that they must repay is seen as the lesser of the two evils.

© 2024 Newsmax Finance. All rights reserved.


StreetTalk
Cash-strapped Americans are tapping into their 401(k)s like never before, some even selecting the option that permits up to a $100,000 withdrawal.
401k loans, hardship withdrawals, retirement savings
552
2023-54-02
Thursday, 02 February 2023 10:54 AM
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