Under federal regulations, some plans allow participants to take out hardship withdrawals from their defined contribution (DC) plans to pay for immediate and heavy financial needs. These include tuition bills for their children.
Sue Unvarsky, chief operating officer at Prudential Financial, tells PLANADVISER that’s why participants’ demands for hardship withdrawals and call center volume tend to peak around August when these bills are reaching parents’ homes. Jack Schumaker of Fidelity Investments says the company’s call centers see similar patterns in the summer time. This potentially means that right now, thousands of working Americans across the country can be putting serious strains on their future retirement savings. Schumaker says that in the last 12 months ending June 30, about 2.2% of the firm’s 15.1 million 401(k) participants took out a hardship withdrawal.
He adds that around this time, staff at Fidelity’s call centers undergo reinforcement training and heavier staffing to not only deal with the expected hike in call volume, but also to ensure participants are being guided through all their choices and given information about the implications of each.
“Our obligation is to educate participants about their options whether it’s a loan, a hardship withdrawal or another option outside their 401(k) plan,” explains Schumaker. “From there, we will get into helping the participant explicitly understand what the ramifications of the decision will be.”
For example, a hardship withdrawal rarely comes at the sticker price. Hardship withdrawals are subject to income tax and an additional 10% tax on the amount taken out if distributed before the age of 59-and-a-half. Employees are also barred from making elective deferrals to the plan for at least six months after the hardship distribution. However, a bill addressing withdrawals has been introduced to reverse the latter.
Unvarsky says one of the biggest downsides to taking out a hardship withdrawal is that it diminishes a participant’s ability to make the most out of compounding earnings. Moreover, it’s often difficult for a participant to put the amount of money withdrawn back in the plan.
“If I took out a $50,000 hardship withdrawal, it decreases my final savings by roughly $100,000 over the next 12 years assuming a 6% return on earnings,” explains Unvarsky. “If I’m in my mid-40s when I do that, I may not retire for another 25 years.”
While Unvarsky says she’s seen hardship withdrawals as little as $2,000, she has seen some reach above $40,000. Schumaker says the average amount withdrawn as hardship distributions from 401(k) accounts served by Fidelity in the last 12 months ending June 30 was $5,730. On average, this accounted for 21.9% of a person’s 401(k) balance.
However, there are alternatives to taking a hardship withdrawal from DC plans to pay for higher education expenses.
NEXT: Finding Alternatives
While taking a loan from a DC plan account balance is not ideal, it may be better than taking a hardship withdrawal. “If you take a loan from your plan, you immediately set yourself up for a repayment schedule,” says Unvarsky. “We also encourage people to explore student loans for their children and be a cosigner. We also try to make sure they have filed for federal student aid. It may be more cost effective to take a student loan as opposed to tapping into retirement plans.”
However, several participants resort to hardship withdrawals after they’ve exhausted other resources including plan loans and emergency savings. And turning to DC plan assets before retirement can be as much an emotionally draining experience as it is a financial one. That’s why Schumaker and Unvarsky agree that empathy is the key driver of many conversations taking place in their call centers.
“If you’re approaching the need for a hardship withdrawal, you’re in a dire situation and you may be in a state of anxiety,” says Schumaker. “So we try to really spend time with the participant and make sure they fully understand what’s going on.”
However, a sound strategy around fostering financial wellness among participants may help employees avoid needing a hardship withdrawal or loan in the first place. Various providers offer different tools and resources that can guide participants in every facet of their financial lives from budgeting to emergency savings and developing attainable retirement savings goals.
Unvarsky says Prudential focuses on meeting these goals through multi-channel communication. “If customers sign up to our website, they’ll find resources and tools that will educate them on the importance of saving for retirement and calculating how much they should be saving to achieve their goals.”
Research by the International Foundation of Employee Benefit Plans also suggests that plan design and education can help limit participant loans. But education alone is not enough. The information needs to be actionable and a degree of effort needs to be put in place to promote engagement and raise awareness. The human component can help in this regard.
Unvarsky says her firm works with different companies to run on-site educational campaigns where employees can discuss financial topics face-to-face with professionals.
“When a person enrolls in a plan, we’re going to educate them about the purpose of the [DC] plan as a long term savings vehicle for retirement and how to build other emergency savings,” says Schumaker. “But we recognize that when the person calls in, they may not have those in place and are in a last resort … Each participant has a unique need and we need to be sensitive to that. Our job fundamentally is to educate the participant on what they have available to them and what the implications can be. The human interaction is a critical part to that.”