Other 401(k) savers have been smacked around by inflation. Feeling they had no other recourse, they have been tapping their retirement funds.
It’s been a better investing year for some and a challenge for others.
As it does every quarter, Fidelity Investments, one of the largest managers of workplace plans, looked at savings behaviors and balances for the more than 45 million individual, 401(k) and 403(b) retirement accounts it manages.
The most recent, third-quarter results were a mix of positive and concerning findings.
The average 401(k) balance dropped to $107,700, down 4 percent from the previous quarter. The average 403(b) account decreased 5 percent to $97,200, while IRAs were down 4 percent to $109,600.
“We did have a little bit of market uncertainty in Q3, which contributed to the balances being down a bit for the quarter,” said Mike Shamrell, vice president of thought leadership for Fidelity’s workplace investing division. It’s the group that works with employers.
However, taking a longer view, on average, 401(k) and 403(b) balances jumped 11 percent year-over-year. IRA accounts were up by 8 percent.
The other good news is that the total savings rate for the third quarter — a combination of employee and employer contributions — was 13.9 percent, up slightly from a year ago.
“We found that people are still contributing consistently to their retirement accounts,” Shamrell said. “We did not see people pulling back on their contribution rates.”
Here’s another good sign.
Employers continue providing matches to employee contributions.
“A lot of times when there’s market uncertainty, there have historically been some employers who dialed back a little bit on their match,” Shamrell said.
But there were some worrisome financial moves by retirement plan participants. Most concerning were retirement plan loans and hardship withdrawals, where Fidelity reported an uptick. “In-service” withdrawals subject to taxes and an early-withdrawal penalty also rose.
Inflation and cost-of-living pressures drove those jumps, according to Fidelity.
In the third quarter, 2.8 percent of retirement plan participants took a loan from their 401(k), up slightly from 2.4 percent in the same period a year ago. The percentage of workers with outstanding loans was 17.6 percent, up from 16.8 percent in the third quarter of 2022.
Some employers allow workers to take distributions without hardship, but this “in-service” withdrawal can be costly. The money is subject to income taxes, and if the worker is under 59½ years old, there could be an additional 10 percent penalty.
Fidelity said 3.2 percent of 401(k) participants took an in-service withdrawal in the third quarter, up from 2.7 percent a year ago.
The third-quarter analysis also found that 2.3 percent of workers took a hardship withdrawal from their 401(k), up from 1.8 percent for the same period in 2022. The top two reasons behind this uptick were medical expenses and avoiding foreclosure or eviction, Fidelity said.
Although not required, a retirement plan may allow an employee to take hardship distributions. However, the IRS says the withdrawal must result from “an immediate and heavy financial need” and be “limited to the amount necessary to satisfy that financial need.”
The catch: Hardship withdrawals are generally taxed as ordinary income. And if you are younger than 59½, you may be ordinarily subject to an additional 10 percent early withdrawal penalty. However, the IRS allows exceptions voiding that 10 percent penalty, including covering some unreimbursed medical expenses.
As part of the Secure Act 2.0, starting in 2024, retirement plans can allow employees to withdraw up to $1,000 per year for an emergency expense. This withdrawal is not subject to the usual 10 percent early-withdrawal penalty.
“We are keeping our eye on the number of participants who are having to tap their retirement savings in light of a lot of the financial uncertainty that they may be experiencing,” Shamrell said.
If you’re struggling and eyeing your retirement funds as a place to grab needed cash, talk to the plan administrator or your human resources department about which withdrawal is right for you. But keep in mind, you are swiping money meant for your older self.
Consider the following pros and cons if you feel you have no choice but to tap your retirement money.
Hardship withdrawal. Pro: You don’t have to pay the money back. Con: The distribution is generally taxed as ordinary income, plus there’s an extra 10 percent penalty if you’re under 59½. This means the amount you net minus taxes could be far less than you anticipate. If you don’t qualify for the IRS exceptions, you need to plan to set aside money for taxes, including the early-withdrawal penalty if it applies. The last thing you need is to be hit with a huge tax bill, which could result in additional penalties if you can’t pay Uncle Sam.
Plan loan. Pro: You don’t have to pay income taxes or face the 10 percent early withdrawal penalty on the loan disbursement. You pay interest on the loan, but it goes to your 401(k) account. Con: If you’re living paycheck to paycheck, having a 401(k) loan could make managing your budget tougher.
Taking money out of your retirement may be your only option to handle a financial crisis, but just be sure you understand all the consequences.
