How Can Raiding Their 401(k) Hurt Employees?

Paul McEwan | September 13th, 2010

Fidelity Investments recently announced that the number of workers borrowing against their retirement accounts has reached a 10-year high. Given the financial stress that many workers face today, the numbers are not that surprising, but the long-term consequences can be.

Fidelity administers 17,000 plans, representing 11 million participants. In the second quarter of 2010, 62,000 workers took a hardship withdrawal, compared to 45,000 for the same period in 2009. However additionally troubling was that 45 percent of participants who took a hardship withdrawal a year ago also took another one this year.

To receive a hardship withdrawal, participants must demonstrate an immediate and heavy financial need, as defined by IRS regulations. These needs include certain medical expenses, costs toward the purchase a primary home, tuition or education expenses, payment to prevent foreclosure or eviction, burial or funeral expenses or repair of damage to a primary home.

Hardship withdrawal provisions are not mandatory in 401(k) plans. And with good reason. The withdrawals can severely impact a participant’s retirement savings. The withdrawn funds are subject to taxes, and if the worker is younger than 59 ½, he or she will pay a 10 percent penalty for early withdrawal. After a hardship withdrawal is taken, salary deferrals must be suspended for six months. So not only does the participant forgo the ability to save for six months, he or she also misses out on any employer match that would normally be offered during the period.

Fidelity also reported the number of workers taking 401(k) loans grew from 9 percent in 2009 to 11 percent in 2010. The percent of participants with outstanding loans increased to 22 percent in the second quarter of 2010, the highest in a decade.

Employers can prevent hardship and loan withdrawals by not providing them in the plan document. By not providing the option of withdrawals, plan sponsors can avoid abuse of withdrawals by plan participants. Contact your financial advisor for assistance in writing this language into your plan document.

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