Just because 401k plan participants can easily take a hardship withdrawal today doesn’t mean they should, of course.
Since the Bipartisan Budget Act of 2018 eliminated the requirement to take all available plan loans before obtaining a hardship withdrawal, the folks at Fidelity Investments have been keeping an eye on how this change might impact participant behavior.
What they’ve seen so far? While the percentage of participants taking loans and hardship withdrawals has remained relatively consistent, there has been a slight decrease in the percentage of participants taking loans, and a slight increase in the percentage of participants taking hardships since passage of the BBA.
Participants taking hardship withdrawals spiked to 4.4% in 2019, compared to 2.7% in 2017, according to a Fidelity Whitepaper on the topic. Loans remained consistent at 9.2% in 2017 and 2019. The average hardship withdrawal was $3,800 as of the end of September 2019.
Another recent study, this one from the Plan Sponsor Council of America (PSCA), found the percentage of participants taking a hardship withdrawal dropped from 2.3% in 2017 to 1.8% of participants in 2018—before the BBA—but the study was completed before 2019 statistics were available, where an uptick from the new rules would likely have been apparent.
Transamerica Center for Retirement Studies says almost one in three workers (29%) have taken a loan and/or hardship withdrawal from retirement accounts.
Hardship doesn’t mean contributions have to stop
The BBA also expanded and modified what qualifies as a “hardship,” and changed an old provision to allow participants to rebuild their 401k savings more quickly by contributing to it right after taking a hardship. The old rule required a six-month suspension from 401k contributions.
As a result, Fidelity found only 3% of participants taking hardship withdrawals have actively lowered or stopped their deferrals by choice.
For the 96% of participants who took a hardship and continue to save, it could mean an extra one-third of an average hardship withdrawer’s annual salary in retirement.
In a hypothetical example from the paper, Fidelity calculated what the ending balance in retirement would be for a 45-year-old participant with an annual income of $68,500 and a total savings rate of 7%, who took two separate hardship withdrawals one year after another.
In one scenario, the participant chose to continue saving in the plan and received the company match, and in the other scenario the participant stopped saving for six months after each hardship request. This example illustrates the importance of continuing to save, as it could mean an additional $20,500 for this participant at retirement.
Fighting 401k leakage
The Fidelity paper notes taking a loan will have less of an impact on participants’ long-term savings and is generally a better option than taking a hardship. While both loans and hardship withdrawals are leading causes of 401k leakage, at least loans are expected to be paid back while participants have no obligation to pay back a hardship withdrawal.
Hardship withdrawals do come with an income tax payment as well as a 10% penalty for those under age 59½.
For some participants, taking a hardship may be their most realistic option and the only thing that can keep them from a severe consequence such as losing their home.
To help participants who are in an expected or unexpected financial crisis, the Fidelity paper says plan sponsors should consider hardship withdrawal processes that allow for quick and streamlined access to assets.
Many DC plans today require manual approval, which delays processing time, and it can take an average of four to nine calendar days for participants to get their money. To help participants who are in a financial hardship situation get their money quickly, a preapproved digital experience can reduce the processing and delivery time frames by 20%-25% (depending on various delivery methods available). For participants experiencing heightened financial stress, every day counts.
Plan sponsors can still require loans first
The Fidelity paper also points out that although the BBA no longer requires plan loans before taking a hardship, it does allow plan sponsors to tinker with their plan design so they can still require taking a loan before requesting a hardship, something plan sponsors need to consider closely.
More findings
- Preventing eviction or foreclosure is the No. 1 reason participants have taken hardships over the past 10 years, followed by medical costs, education, and home purchase/repair. Source: Fidelity Investments recordkept data as of 6/30/19.
- Participants who have taken a hardship are nearly three times more likely to feel “always” stressed in general and three times more likely to have “a lot” of stress about their financial situation than those without a hardship. Source: Fidelity Investments Total Well-Being Research, 2017.
- Of the nearly 50% of participants who had a financial emergency within the past two years and did not have an emergency savings account in place, 42% took a loan or withdrawal from their DC plan and 38% used a credit card to cover the expense. Source: Fidelity Investments 2016 Participant Panel Survey.