401(k) hardship withdrawals are rising as Americans are under financial stress

401(k) Hardship Withdrawals Rising As Americans are Under Stress

The New York Post recently reported that Americans are raiding their retirement accounts to cope with inflation. Fidelity Investments said that 2.3% of workers withdrew money from their 401(k) or IRAs in the last quarter. This number increased from 1.8% of those surveyed in the same period in 2022.

The IRS hits savers hard for withdrawing money early from these retirement vehicles, levying income tax on the money plus a 10% penalty if the funds are not used for special circumstances like medical bills or tuition.

In a passive investing world where stocks perpetually rise due to inflows into 401(k) and IRA accounts, these hardship withdrawals are a cautionary sign that economic distress could cause those flows to run in reverse.

In addition to hardship withdrawals, loans against 401(k) balances increased as well, with 2.8% of account owners borrowing money against their retirement savings. This is up from 2.4% in Q3 2022. Not all 401(k) plans offer the ability to take loans out against the current balance, but those that do must adhere to IRS rules, which limit the amount to $50,000 or 50% of the account balance, whichever is less.

The American Society of Pension Professionals & Actuaries has more on this topic. One interesting difference they note is how Gen Z is favoring IRA accounts over 401(k) accounts. Boomers are saving at the highest levels in the workforce with a savings rate of 16.7%.

The Fidelity survey was conducted in the third quarter of 2023. It is comprised of data on account balances for 45 million retirement account holders in 401(k), 403(b), and IRA accounts.

Passive investing has outperformed virtually all other investment strategies, due to the constant inflows and virtually no outflows. Retirement accounts are primarily invested in some variant of the S&P 500 index, so all the money is essentially flowing into the same stocks in the same percentages, and index funds almost never sell. However, if outflows start to overwhelm inflows, the consequences will be disastrous.

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