More people are taking early 401(k) withdrawals: Here's why

00:00 Speaker A

So, Kelly, we just mentioned that 10% penalty. On the surface, this doesn’t sound like a smart move, but are there situations where an early 401k withdrawal actually does make sense?

00:16 Kelly

Well, thank you so much for having me on your show today. It’s really great to be here. Yes, it does make sense in some cases because emergencies do happen, and sometimes people just need cash and liquidity. When we look in our data as to why people are taking early withdrawals, the top two reasons are avoiding eviction, as well as paying for medical expenses. So what we’re really trying to emphasize is the need for having an emergency reserve so that the retirement wealth, or the long-term savings can be safe for the intended use.

00:58 Speaker A

So would you say that 10% penalty is the biggest downside when it comes to taking money out early, or are there other long-term impacts people might not be thinking about?

01:09 Kelly

Yeah, no, that’s really great point. I would add two more things. One is taking money out of your 401k means you have to pay taxes on the money that you did not have to pay taxes going into those savings. And more importantly, for me, is the foregone investment gains that people could have had over many decades of long-term compounding. So it really does impact people’s retirement wealth at the end of the day.

01:41 Speaker A

And the study showed nearly 5% of participants took withdrawals this year. What does that tell you about the financial pressures Americans are facing right now? Because, as you were just mentioning, we did we can sometimes see these trends emerge when people get evicted or have some sort of other emergency.

02:00 Kelly

Right. The 5% is a slight uptick from what we had seen in recent years. But what’s really important to note is that it’s still happening to a rather contained group of, small subset of, people. We see in our data that more people than ever are saving towards their retirement in their 401k accounts. Eight out of ten workers that we work with are saving towards their retirement, and they’re saving at the highest rate that we’ve seen, which is 12%. So the uptick in hardship withdrawal, and some of the cash out numbers that we see, are highlighting that our retirement system may not be perfect, but we made a lot of progress to making it work for the broad set of population as we can.

02:52 Speaker A

And are there any trends you’re seeing demographically, or otherwise, when it comes to who is tapping into their 401k early?

03:03 Kelly

The people, when they change their jobs, they tend to cash out their entire 401k balance. We see that about one in three workers, when they leave their jobs, they tended to cash it out altogether. And when we look by different demographics, it happened more so with people whose income can be fluctuating. So inconsistent paychecks. So think gig economy workers, as well as hourly workers. They tended to cash out more so than salary workers. But, again, the good news is, when they had an emergency savings of a moderate amount of, let’s say, $2,000, they tended to cash out a lot less, and they had better savings behaviors by saving more towards their retirement as well as taking less loans and less hardship withdrawal.

03:55 Speaker A

So for workers who are facing a cash crunch but want to protect their long-term retirement savings, what other options should they consider first?

04:06 Kelly

Well, it’s really comes down to financial planning. In order to help protect our long-term assets, like retirement, we really need to get our house in order of having an emergency savings. Thinking about the shocks that we may endure from spending shocks, as well as the income shocks that I just mentioned, people really need to be thinking about the holistic financial um health of our balance sheet.

04:35 Speaker A

And, finally, for those trying to rebuild their 401k after making a withdrawal, how do you get back on track?

04:43 Kelly

It really comes down to saving, and maximizing the employer match to the extent that is possible. But it really comes down to little efforts that we can make towards the long-term goal of being able to retire successfully.

04:59 Speaker A

Kelly, thanks so much. You can scan the QR code below for more 401k content.