Recession blues: 401(k) loans and hardship withdrawals on the rise

Fidelity Investments, one of the nation's providers of workplace retirement savings plans, has released its quarterly data on the state of the 401(k) that show positive, steady savings behavior by the majority of participants. However, it also cited an increase in the use of loans and hardship withdrawals by participants.

"The majority of participants continue to make saving through their workplace plans a priority," said James M. MacDonald, president, Workplace Investing, Fidelity Investments. "However, the current economy has forced some workers to borrow from their 401(k) accounts in order to pay for critical living expenses, ultimately jeopardizing their future retirement."

The average 401(k) account balance as of the end of the second quarter was $61,800, up 15% from the same time last year, but down from the end of the first quarter of 2010. The average deferral rate, which refers to the percentage of a participant's salary saved, held steady during the quarter at about 8% with one-in-three (32%) participants deferring at 10% or higher. Similar to the first quarter, more participants increased their deferrals (5.3%) than decreased (2.9%) in the second quarter.

Loans and Hardship Withdrawal Activity Rising Especially Among Middle Aged

While the majority of 401(k) participants continued to save during the quarter, the percentage of participants either initiating a loan or a hardship withdrawal increased. Loans initiated over the past 12 months grew to 11% of total active participants from about 9% one year prior. The portion of participants with loans outstanding also increased two full percentage points in the second quarter to 22%. The average initial loan amount as of the end of the second quarter was $8,650 with an average loan duration of three and half years.

"We recognize that for some, taking a loan or a hardship withdrawal from their 401(k) may be their only option because it's their only form of savings," said MacDonald. "However, we want to make sure that before workers tap their retirement accounts prematurely, they are fully educated about both the penalty that may be incurred and the long-term implications for their retirement."

During the second quarter of this year, 62,000 participants initiated a hardship withdrawal, as compared to 45,000 participants who initiated one during the prior quarter. As of the second quarter, 2.2% of Fidelity's active participants took a hardship withdrawal, up from 2.0% one year prior. Additionally, 45% of participants who took hardship withdrawals one year prior also took a hardship withdrawal in the 12 month period ending in the second quarter of this year. Plan sponsors report that the top reasons why participants are taking hardship withdrawals are to prevent foreclosure or eviction, pay for college, and the purchase of a primary residence.

Fidelity has found that the average age of those taking a loan or hardship withdrawal is between 35 and 55 years old - a worker's peak earning years - when individuals often have to deal with multiple, competing, financial challenges. Distributions from a 401(k) or 403(b) are taxed as ordinary income, plus if you are under age 59½ you may be subject to a 10% early withdrawal penalty.

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