A 401(k) savings account is supposed to be a key component of an employee’s retirement plan. Instead, recent reports indicate that for one-quarter of Americans, their retirement savings plans have become rainy day, emergency funds.
According to a report by Hello Wallet, a personal finance Web application led by former Brookings Institute scholar Matt Fellowes, 25 percent of households withdrew or borrowed savings from their 401(k) or other similar plans for non-retirement spending. The total annual amount withdrawn is $70 billion annually.
Not even the 10 percent penalty, capital gains taxes and income taxes on withdrawals are deterring people in a financial bind from dipping into their 401(k) plans.
Hello Wallet calls retirement fund withdrawals, loans or cash-outs breaches or leakages and it recommends that employers provide better investment guidance for their employees.
There is any number of reasons why people breach their 401(k) savings. Most people, 52.8 percent, are using the cash to pay off a large bill, loans or debt, stated the Hello Wallet report. The next largest group, 12.3 percent, withdraws to pay for housing. Only 2.5 percent spend their savings on a frivolous expense like a vacation.
“The breach tends to be especially big when people are between jobs,” reported The New York Times. “Earlier this year, Fidelity (Investments) revealed that 35 percent of its participants took out part or all of the money in their workplace retirement plans when leaving a job in 2013.”
Breaches have become so common that 401(k)s and similar IRAs are no more “a system of retirement accounts,” Stephen P. Utkus, the director of retirement research at Vanguard, told The New York Times. “In effect, they have become dual-purpose systems for retirement and short-term consumption needs.”
Some employers force people with low-balances out of the plan, and according to Fidelity Investments, 72 percent of kicked-out account holders took the cash instead of rolling it over into an IRA.
People also often to cash out when they change jobs, reported MarketWatch, and withdrawing money is most common among people with already meager holdings.
And any breach, loan or withdrawal, can permanently affect a person's retirement savings. The among of 401(k) assets that leaked out in 2013 was 1.2 percent.
"That number may sound small," stated MarketWatch, "but it results in balances at retirement that are almost 20 percent smaller than they would have been in the absence of leakages."
So what’s to be done about shrinking 401(k) accounts?
Hello Wallet’s report recommended that companies provide financial guidance to help workers better manage their monthly incomes to prevent future breaching. It also suggested that employers encourage workers to also have emergency savings funds since “the lack of emergency savings has the strongest association with the likelihood that workers will breach their retirement savings.”
Despite Hello Wallet’s warning against dipping into retirement, Georgette Jasen of The Wall Street Journal said that when done smartly and as a last resort, using 401(k) funds can be a lifeline.
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