A new guide published by Fidelity examines the critical topic of retirement plan hardship withdrawals, with the objective of improving the long-term financial health of those who take them.
Earlier this year, in an interview with PLANADVISER, Kevin Barry, president of workplace investing at Fidelity, warned that hardships withdrawals had increased 40% in Fidelity’s book of business since the passage of the Bipartisan Budget Act of 2018. At the same time, the rate of retirement plan participants taking loans had fallen 7%.
Barry cited the fact that the Budget Act provided that a distribution from a 401(k) or similar tax-qualified retirement plan will not fail to be treated as made on account of hardship merely because the employee did not first exhaust any available loan from the plan. In addition, the law expanded the types of contributions and earnings a plan may make available for hardship distributions, and it directed the IRS and Treasury Department to eliminate the safe harbor requirement to suspend participant contributions for six months in order for the distribution to be deemed necessary to satisfy an immediate and heavy financial need.
The new guide was organized with these facts and figures in mind.
“We know that for some participants, taking a hardship may be their only option and may be a ‘lifesaver,’” it says. “To understand how we can help those who are in financial distress, we looked at the changes to hardship withdrawal rules, recent participant behavior, and the well-being of those taking hardships.”
In its analysis, Fidelity finds some good news in that, since the Budget Act, plan sponsors are no longer required to suspend participant contributions to the plan after a hardship withdrawal. As a result, only 3% of participants taking hardship withdrawals have actively lowered or stopped their deferrals by choice.
“For the 96% of participants who took a hardship and continue to save, it could mean an extra one-third of an average hardship withdrawer’s annual salary in retirement,” the analysis suggests.
The Fidelity guide presents a hypothetical example of what the ending balance in retirement would be for a 45-year-old participant with an annual income of $68,500 and a total savings rate of 7%, who took two separate hardship withdrawals one year after another. In one scenario, the participant chose to continue saving in the plan and received the company match, and in the other scenario the participant stopped saving for six months after each hardship request. The example illustrates the importance of continuing to save, as it could mean an additional $20,500 for this participant at retirement.
Another piece of good news is that Fidelity’s analysis suggests the overall rate of hardship withdrawals remains low historically. Of those who do take hardship withdrawals, 73% are taken for two primary reasons. The first is to prevent eviction or foreclosure, and the second is to pay uninsured and unreimbursed medical expenses. For both hardship reasons, Fidelity finds, the average amount is $2,900 and the average number of withdrawals taken per participant is 1.5 per year.
Among the troubling findings in the analysis is that roughly one in eight participants has an unpaid medical bill, putting them at increased risk for needing hardship withdrawals in the future.
“Eighty-four percent of the participants with unpaid medical bills are financially unwell, and virtually none have excellent financial wellness,” the analysis explains. “No other forms of debt are linked as strongly to so many dimensions of well-being, not even student debt or credit card debt. … Our well-being study highlights that participants who take hardship withdrawals from their plans have more stress than other defined contribution [DC] participants across the board and could benefit from help in many areas, such as maintaining a budget, managing debt, and saving for short-term emergencies and for the future.”
Also troubling, Fidelity finds participants who have taken a hardship are nearly three-times more likely to feel “always” stressed in general and three-times more likely to have “a lot” of stress about their financial situation than those without a hardship.
When it comes to helping folks who have taken hardship withdrawals, Fidelity has a number of suggestions. For starters, the firm says, one way to help decrease the likelihood that a participant will tap into his or her DC plan when experiencing a financial hardship is to help them understand the importance of having an emergency savings account. Plan sponsors may even consider offering “sidecar” savings accounts linked to the payroll system.
“Our research illustrates of the nearly 50% who had a financial emergency within the past two years and did not have an emergency savings account in place, 42% took a loan or withdrawal from their DC plan, and 38% used a credit card to cover the expense,” the analysis warns. “We recommend aiming to have the equivalent of three to six months of income in an emergency fund, for big emergencies like job loss or a health crisis.”
As Fidelity explains, it’s not just the financially unwell who will benefit from assistance with generating emergency savings. One-third of financially established participants do not have a sufficient emergency savings in place, the analysis shows. Fidelity also suggests sending “targeted and relevant messages” to participants who are withdrawing money from their plan to ensure they get the education and resources they need—especially communicating the different options to those who stop saving during a hardship or to those who should consider a loan before a hardship.
According to Joshua Waldbeser and Monica Novak, partners with Drinker Biddle and Reath, even after the changes made by the Budget Act in 2018, the eligibility for hardship withdrawals still hinges on a participant experiencing a heavy and immediate financial need. The law simply eased the documentation requirements and made it so that participants don’t need to exhaust loan options prior to taking a hardship withdrawal and don’t need to suspend contributions for six months. Further, it permits participants to take withdrawals not only from elective deferral contributions, but also from qualified non-elective contributions, qualified matching contributions and other earnings.
As Waldbeser and Novak explain, plan sponsors still have a significant amount of discretion when it comes to setting limits on plan loans and hardship withdrawals. Under the law change they are not permitted to require a six-month suspension of contributions post-hardship, but they can still do such things as limit the amount of withdrawals. They add that existing IRS guidance suggests that hardship withdrawal-related plan amendments do not have to be made until December 31, 2020. This means plan sponsors can implement their process changes today and then work with their providers over the coming year-plus to get plan documents in order.
Speaking with PLANADVISER earlier this year, Mike Zovistoski, managing director at UHY Advisors in Albany, New York, said he has not witnessed many participants taking out hardship withdrawals. He believes one of the main reasons is that employees do not always want their employer to know about what they may feel is an embarrassing financial situation.
“Concerns about having your employer know your financial status has discouraged a lot of employees from taking hardship withdrawals,” he says. Furthermore, most of his plan sponsor clients “have the paternal instinct,” Zovistoski says. “They want to protect employees from themselves,” so he does not expect many of his clients to make plan design changes to permit their employees to take out a large hardship withdrawal without first going down the loan route.