Recession Prompts More People to Tap Retirement Savings
The recession is eroding retirement security even more deeply, as more Americans tap into all available resources to meet current needs. In many cases, that means tapping into 401(k) accounts, IRAs, or taking Social Security early.
Fidelity Investments reported recently that 11 percent of its active 401(k) plan participants borrowed or withdrew funds from their accounts during the 12-month period ended June 30, up from 9 percent a year ago--a 10-year high. The portion of participants with loans outstanding also increased two full percentage points in the second quarter to 22 percent. What's more, five percent of the participants who took a hardship withdrawal last year did so again this year.
Along with that report comes data suggesting that the number of families tapping retirement accounts to pay for college expenses this year has doubled. A new study by Gallup and student lending giant Sallie Mae of more than 1,600 families with college-age children found that 7 percent withdrew or borrowed funds from a 401(k) or IRA for the 2009-2010 academic year, up from 3 percent in the previous year.
And the amounts withdrawn or borrowed increased to $8,554, up from $5,318 in the previous year. "That kind of change in a single year is very significant, and very worrisome," said Sarah Ducich, senior vice president, public policy at Sallie Mae. The key economic concerns expressed by parents responding to the study included rising tuition, reduced value of their home and a big increase in worries about declining income due to job loss.
Retirement accounts can be tapped under certain circumstances without incurring a withdrawal penalty.
The Internal Revenue Service allows hardship withdrawals from a 401(k) for limited and very specific purposes, including funding of education, medical expenses and funerals, paying mortgage debt or to avoid foreclosure or eviction. The IRS requires employers to meet tough qualification requirements, and employees must submit extensive documentation proving the hardship.
A Roth IRA can be tapped without penalty so long as the funds have been invested a minimum of five years. However, the funds do generate tax liability as ordinary income--which can impact eligibility for need-based financial aid in the following year.
Withdrawing funds from a standard IRA before age 59 ½ generally triggers a 10 percent tax penalty, and the funds also will be taxed as ordinary income (There are certain "special circumstances" that can exempt you from this rule; see IRS Form 590 for more details.)
Borrowing from a 401(k) account comes with special risks. These loans have five-year terms; if you leave your job for any reason before then, you must repay in full--or the loan is treated as a taxable distribution. Plus, if you're under age 59-1/2, you'll pay a 10 percent penalty if you default on the loan.
Then there's the long-term damage to your retirement savings. Borrowing or withdrawing funds will inflict serious damage because of the time those funds won't be earning investment returns. Also lost is the opportunity to earn returns on new investments; in most cases, you can't make contributions while you have a loan outstanding, and you can't contribute for six months after you make a hardship withdrawal.
A 35-year-old investor who borrows $25,000 from her 401(k) and repays it over five years reduces the balance at retirement by about 17 percent, according to the Transamerica Center for Retirement Studies (The example assumes retirement at 65, a $5,000 annual contribution to the 401(k) and a starting vested balance of $50,000.)
Likewise, a $50,000 hardship withdrawal would set back that same investor at retirement by a whopping 45 percent.
The nest egg raid also extends to Social Security, where the poor economy is pushing more Americans to file for early benefits--a move that reduces lifetime benefits sharply in most cases. Under Social Security rules, your lifetime benefits will be reduced based on an actuarial projection of your longevity if you file before the current full retirement age of 66. Starting at 62 means you retired four years early; the net effect is that your annual benefits will be reduced permanently by a total of 25 percent.
The Social Security Administration reports that 73 percent of workers who filed for benefits in 2009 were filing early--that is, sometime before their full retirement age. That number hasn't changed much since the onset of the economic downturn, but it's an overwhelmingly large percentage of all filers.
Read more: Saving for College vs. Saving for Retirement
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