Recently, Fidelity Investments released its analysis of savings accounts in the third quarter of 2023. This data covered more than 45 million retirement accounts, including 403(b) and 401(k) accounts, as well as individual retirement accounts (IRAs). The study came to some surprising and frankly concerning conclusions about Americans’ saving habits.
An increasing number of Americans are dipping into their retirement accounts to cover currently due bills. Even worse, this is happening during a time when many retirement savings accounts are down in value, which means the impact of this spending will only compound over time in terms of the lost revenue from interest. Certainly, people understand the detrimental effects of early withdrawals, especially in negative market environments. That they are continuing to make withdrawals underscores the dire state of many Americans’ finances. It appears that retirement accounts have become de facto emergency savings accounts for many people.
More Americans Borrowing from Retirement Accounts
The Fidelity data from the third quarter of 2023 showed that 2.3 percent of workers withdrew money from their retirement accounts for hardship, an increase from the 1.8 percent rate seen one year prior. During the same period, 3.2 percent of workers took in-service withdrawals. The year prior, only 2.7 percent of people completed this type of transaction. This year, 2.8 percent of people took out a loan from their 401(k), which was an increase from 2.4 percent last year. Notably, this figure is on par with the second quarter of 2022. While these percentages are still small, they show a worrisome trend.
Given these dips into retirement accounts, it is perhaps not surprising that the percentage of workers with an outstanding loan increased to 17.6 in Q3 2023, up from 16.8 in Q3 2022. The most common reasons for taking out these loans, according to Fidelity, were paying medical expenses and preventing foreclosure or eviction. This research is in line with other studies. In a separate Bank of America study, hardship withdrawals increased by 13 percent between the second and third quarters of 2023.
The figures above underscore a growing problem caused by the rapid rate of inflation in the United States and other countries around the world. According to Fidelity, about 80 percent of respondents said that the increased cost of living was causing significant stress, and more than half of respondents indicated that they would not be able to handle even $1,000 in unexpected expenses in a given month.
This explains why so many people end up making early hardship withdrawals from their retirement accounts—it may be the only choice they have to cover a large, unexpected expense. While not advisable, these withdrawals may be a slightly better option for some people than using a credit card or going further into debt.
The Resounding Effects of Retirement Savings Withdrawals
These withdrawals can really hurt savers down the road. Upon withdrawal, the money is taxed as normal income. In addition to that, savers will face a 10-percent penalty for early withdrawals before age 59.5, unless the money qualifies for one of the few IRS exceptions. These exceptions include a certain amount for first-time homebuyers, qualified tuition payments, and a handful of covered medical expenses. Outside of these exceptions, the penalty must be paid.
Employers can also offer some non-hardship withdrawal options, including loans. These loans are made to yourself and must be repaid with interest. Typically, the loans must be repaid within a period of five years and with enough interest to avoid resounding downstream effects. The payments, along with interest, go straight back to your account. However, the availability of such loans is up to individual employers.
The major downside of the 401(k) loan is the possibility of leaving your current employment. If you leave your job while you still owe money to yourself through this loan, you will likely need to repay the entire balance at once. If you can’t, you face the real probability of getting hit with taxes for the amount outstanding, not to mention the 10-percent penalty. Unfortunately, this money goes to the government rather than back to your retirement savings. The upshot is that you may end up in a difficult position if a new job offer comes along when you have one of these outstanding loans. Before taking out a loan from your 401(k), it is important to consider this possibility.
A Surprising Commitment to Retirement Savings Among Americans
Remarkably, Americans have not given up on saving for retirement, even as inflation has pushed the cost of living higher. The percentage of people putting money from each paycheck in a retirement account increased from the third quarter of 2022 to 2023. Still, given the increasing number of withdrawals, it may be that people treat retirement accounts differently than they did in the past—more like emergency savings accounts than nest eggs for their golden years.
It’s possible that the withdrawals could indicate growing faith in the retirement savings system in the United States; people may have faith in the ability of their accounts to recover from early withdrawals over time. After all, average account balances continue to grow despite the financial setbacks presently affecting Americans. Compared to the third quarter of 2022, average 401(k) values were up by 11 percent, even if they are slightly down from the second quarter of this year. Moreover, compared to 10 years ago, the average 401(k) value is up by 27 percent.