As inflation slowly recedes from last year's highs, many Americans are still struggling to pay their bills. Newly released data from Bank of America reveals concerning signs that retirement savers are increasingly borrowing from their 401(k)s to make ends meet.
Growing 401(k) hardship and loans
Bank of America (BoA) recently released its 2023 Q2 "Participant Pulse" report, which tracks the retirement saving behavior of over 4 million Americans during the three months ending June 30, 2023. The employee retirement programs analyzed in the report cover more than 4 million total participants with positive account balances.
So what does the data say? First, that retirement savings are coming under growing strain in the face of still-elevated living costs.
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BoA's report reveals that the number of retirement plan participants taking hardship distributions increased a concerning 36% year-over-year to a total of 15,950 participants. This participant total also represents an equally worrying 12% increase just over BoA's Q1 2023 report, which already showed an increasing number of hardship distributions.
On top of that, the percentage of participants simply borrowing from their workplace plan grew to 2.5% (75K participants) in Q2, up from 1.9% (56K participants) in Q1. The latest report data also registers an annual increase over the 2.2% of participants who took hardship distributions in Q2 2022.
Finally, BoA's data shows that average quarterly contributions dropped 23% between quarters, from $1,880 in Q1 to $1,460 in Q2.
Reasons for optimism
The data isn't entirely negative, however. According to Lorna Sabbia, head of retirement and personal wealth solutions at Bank of America, “The data from our report tells two stories – one of balance growth, optimism from younger employees and maintaining contributions, contrasted with [the aforementioned] trend of increased plan withdrawals.”
Led by Gen Z and millennial savers, more participants overall increased (10.2%) vs. decreased (2.2%) their 401(k) contribution rate. Gen Z blew every other generation out of the water, with 19.3% increasing their retirement contributions vs. 2.6% decreasing. Millennials held their own with 11.0% increasing vs 2.6% decreasing.
Meanwhile, the average contribution rate held steady at 6.5%, equal to Q1. Savers can also celebrate an average account balance of $82,300 in June 2023, as compared to $75,050 at the end of 2022.
Pros and cons of hardship withdrawals
Unexpected financial expenses are an unavoidable part of life. If you're not lucky enough to have a large emergency fund, it may be tempting to borrow from your future self rather than a bank or credit card issuer. Here are a few ups and downs of taking a 401(k) loan:
Pros:
- You can withdraw up to $50,000 from your 401(k) at a fixed rate that can't be raised over time, as compared to variable credit card rates.
- 401(K) loans aren't reported to credit bureaus like Equifax and don't factor into your credit score, even if you leave your job before paying back outstanding balances.
- You won't be charged late fees for missing a payment.
Cons:
- You still have to pay interest payments on any 401(k) withdrawal.
- You're sacrificing investment gains, ultimately reducing your retirement assets to cover current expenses.
- Loan initiation fees of $25 to $75, as as well as annual charges of $25 to $50, could erase the 401(k) loan advantage over a traditional loan or credit card payment.
- Repaying loans using after-tax dollars means you'll get double-taxed when you eventually receive retirement-age distributions.
- If you leave your job during the repayment period, you may be required to make a balloon payment to repay the loan in full. And if you don't pay it, the outstanding balance counts as taxable income, and you might suffer an additional 10% early withdrawal fee on the outstanding balance.
Another thing to consider is that in 2024, the SECURE 2.0 Act will allow savers to take an emergency distribution of up to $1,000 once during the year, without the additional 10 percent tax that generally applies to early distributions.
Caution: If you don't repay the distribution within the specified time frame, you won't be able to take further emergency distributions for three years.
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