Workers are prematurely drawing down their retirement savings, a sign that households are under increased financial pressure, a worrying development that is likely to worsen if the US economy falls into recession in the coming months.
According to the recent Vanguard Investor Expectations Survey“Investors are feeling more pessimistic about the near-term outlook for financial markets and more need to leverage their retirement savings for cash,” based on October 2022 data from 5 million workplace retirement accounts managed by the mutual fund giant.
To help you develop retirement strategies and avoid early withdrawals, consider partnering with a licensed financial advisor for free.
The number of hardship withdrawals from Vanguard-managed pension plans has reached its highest level since 2004, according to Vanguard, with 0.5% of workers withdrawing money in an emergency. The total of 250,000 hardship withdrawals is worse than during the COVID-19 lockdowns and the Great Recession of 2008 and 2009. Withdrawals are only allowed for what the IRS calls “an immediate and heavy financial need” which often must be documented.
Another sign of financial pressure among workers is the increase in the number of people taking out loans on their 401(k) accounts, which jumped during the Great Recession to more than 1%. In October, Vanguard reported that 0.9% of plan participants were taking out loans.
While 401(k) loans are repaid with interest to the participant’s account, hardship withdrawals cannot be repaid. Under IRS “safe harbor” rules, workers can withdraw money for medical bills, college expenses, rent or mortgage payments to avoid eviction or foreclosure, funeral expenses and home repairs.
Difficulties and other pterm withdrawals from 401(k) and similar business accounts can be particularly risky to a worker’s future retirement security because the account balance is permanently lowered, leaving less cash to generate future returns.
An additional danger for hardship withdrawals is that participants often withdraw more money than their circumstances require in order to pay the resulting taxes and penalties. Workers must pay income tax on the money withdrawn, plus an additional 10% penalty if they are under age 59.5. In some difficult cases, the sentence can be canceledfor example when the money is used to cover unreimbursed medical expenses which total more than 10% of the worker’s adjusted gross income.
“The recent increase in the number of households tapping into their employer-sponsored retirement accounts, however, could be a sign of some deterioration in the financial health of the American consumer,” said Fiona Greig, global head of research and investor policy at Vanguard.
Early withdrawals from retirement accounts are strongly discouraged by financial planners because of the danger they can create in retirement when workers can no longer generate income. Planners also discourage loans, as they can permanently reduce account returns.
How to Avoid Early Retirement Account Withdrawals
People facing financial hardship are encouraged to cut spending, liquidate non-retirement assets, seek government or private assistance, or take out a home loan or other low-interest loan.
People who are not yet in financial crisis are encouraged to build a emergency fund to deal with unforeseen financial hardship, with a recommended minimum of three months of living expenses, or up to one year of living expenses. A preferred strategy is to automatically take money from each paycheck and deposit it in a high-interest savings account or money market account so the money can be easily accessed in an emergency. .
Conclusion
According to a recent Vanguard survey of investor expectations, workers are prematurely dipping into their retirement savings, a reality that could be exacerbated if the U.S. economy falls into a deep recession in the coming months. Workers should explore alternatives to premature withdrawals from retirement accounts, which come with steep penalties, and should consider partnering with a financial advisor for free develop strategies to build their retirement accounts and create an emergency fund.
Tips for saving for retirement
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In order to be ready for retirement, it is important to ensure that your finances are in order and that you have prepared well for retirement. A Financial Advisor can help you create a financial plan, prepare your finances well, and know when is the right time for you to retire. Finding the right financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with up to three approved financial advisors who serve your area, and you can interview your advisor for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, start now.
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If you now know when you want to retire, it might be time to increase your retirement savings. In an ideal world, you already contribute to your 401(k) if you have one, but are you using your employer matching program? Not all employers offer 401(k) correspondence, but if yours does, you should definitely take advantage of it. Typically, without much extra effort on your part, you can get free money in your retirement savings account every month.
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Again, if all that math and planning is too daunting for you, you don’t have to go it alone. Consider using a financial advisor. When looking for the right one, be sure to ask questions to each advisor it will help you get a better idea of what he or she can offer. Thus, you will not end up with an advisor more specialized in debt collection than in retirement planning.
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