Hardship Withdrawals from Retirement Accounts Increased in the Second Quarter: Report
Retirement accounts are a vital financial asset for many Americans. While these accounts are designed to help workers save for retirement, life can get in the way and force them to dip into these funds before they are ready to retire. According to a recent report, hardship withdrawals from retirement accounts increased in the second quarter.
What is a Hardship Withdrawal?
A hardship withdrawal is an early withdrawal from a retirement account that is taken before a participant reaches the age of 59 ½. Penalty-free withdrawals can be made from a qualified retirement plan if an employee experiences specific financial hardships, such as unexpected medical expenses or sudden job loss. However, the withdrawn amount is still subject to regular income taxes.
The Increase in Hardship Withdrawals
A recent report by Fidelity Investments found that the percentage of savers with an outstanding 401(k) loan increased from 22% in the first quarter to 23% in the second quarter. Hardship withdrawals were up even more—up from 1.5% in the first quarter to 2.2% in the second quarter.
One possible explanation for this increase is the COVID-19 pandemic. The pandemic has had a significant impact on the economy, causing many workers to lose their jobs or experience a reduction in income. When faced with financial difficulty, some workers may turn to hardship withdrawals as a way to make ends meet.
Pros and Cons of Hardship Withdrawals
While hardship withdrawals can be a lifeline for workers facing financial difficulties, there are also downsides to consider.
- Provides access to funds when needed
- No penalty if withdrawn for a qualifying hardship
- No repayment required
- Decreases retirement nest egg
- Subject to income taxes
- May incur additional fees or penalties
It’s important to note that taking a hardship withdrawal can have long-term consequences on retirement savings. By withdrawing funds early, participants are not only reducing the amount they have saved but also missing out on potential earnings. Moreover, they may face additional fees and taxes.
Alternatives to Hardship Withdrawals
Before taking a hardship withdrawal, workers should consider other options that may be available.
1. 401(k) Loans
Workers may be able to take a 401(k) loan instead of a hardship withdrawal. The interest rates on 401(k) loans are typically lower than those of other loans, and unlike hardship withdrawals, the money is repaid with interest.
2. Emergency Savings
Workers who have an emergency savings fund may be able to avoid dipping into their retirement accounts altogether. Ideally, emergency savings should cover three to six months’ worth of living expenses.
3. Work with a Financial Advisor
A financial advisor can help workers navigate their financial difficulties and develop a plan that works for their specific situation.
Hardship withdrawals from retirement accounts increased in the second quarter, likely due to the COVID-19 pandemic’s financial impact. While hardship withdrawals can be a lifeline for workers, they should also be aware of the long-term consequences and consider other options before taking this step. By working with a financial advisor or building up emergency savings, workers can better prepare for financial difficulties and avoid tapping into their retirement savings too soon.