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More workers raiding 401(k) plans long before retirement

The number of people tapping retirement plans to pay their bills is raising questions about the effectiveness of vehicles like 401(k) plans.Bluestocking/other

WASHINGTON — A large and growing share of American workers are tapping their retirement savings accounts for nonretirement needs, raising broad questions about the effectiveness of one of the most important savings vehicles for old age.

More than one in four American workers with 401(k) and other retirement savings accounts use them to pay current expenses, new data show. The withdrawals, cash-outs, and loans drain nearly a quarter of the $293 billion that workers and employers deposit into the accounts each year, undermining already shaky retirement security for millions of Americans.

With policy makers eyeing cuts to Social Security benefits and Medicare to rein in the soaring federal deficit, and traditional pensions in long decline, retirement savings experts say the drain from the accounts has dire implications for future retirees.


‘‘We’re going from bad to worse,’’ said Diane Oakley, executive director of the National Institute on Retirement Security. ‘‘Already, fewer private-sector workers have access to stable pension plans. And the savings in individual retirement savings accounts like 401(k) plans — which already are severely underfunded — continue to leak out at a high rate.’’

A report due this week from the financial advisory firm HelloWallet found that more than one in four workers dip into retirement funds to pay mortgages, credit card debt, or other bills. Those in their 40s have been the most likely culprits; one-third are turning to such accounts for relief.

Fresh data from Vanguard, one of the nation’s largest 401(k) managers, show a 12 percent increase in the number of workers who took loans against their retirement accounts or withdrew money outright since 2008.

The most common way Americans tap their retirement funds is through loans, which must be repaid with interest. Those who withdraw money face hefty penalties. In most cases, they not only incur a 10 percent federal tax penalty but also pay capital gains taxes. The costs are financially harmful to families, but money-management firms reap massive fees.


In addition, employers often are subsidizing the accounts with matching contributions on the assumption the money is helping to secure their employees’ retirements.

“I don’t think this can be ignored. Employers are dramatically overpaying for retirement, but it is not benefiting the employee,’’ said Matt Fellowes, a former Brookings Institution researcher who is now chief executive of HelloWallet. ‘‘In many cases, the only one benefiting is the vendor.’’

Since 401(k)s were created by Congress in 1978, concern about the pervasive use of retirement funds for other expenses has grown as other means of retirement security have dwindled.

In 1980, four of five private-sector workers were covered by traditional pensions that paid a fixed benefit based on salary and length of service. Now, just one in five workers has a pension, leaving 401(k)s and similar retirement savings accounts as the primary vehicles for retirees to supplement Social Security benefits.

‘‘Encouraging or enabling people to spend down retirement money in anything other than the most severe circumstances is a terrible mistake,’’ said David John, a senior fellow at the Heritage Foundation.

But millions of Americans, caught between flat wages and high expenses for everything from sending children to college to making home repairs, feel as though they have little choice.

In 2010, 28 percent of participants reported having an outstanding loan against their retirement accounts, a record high, according to a survey of 110 large employers by Aon Hewitt, a human resources consultancy. And nearly 7 percent of employees took hardship withdrawals that year — roughly a 40 percent increase since the recession — while 42 percent of workers cashed out their plans, rather than roll them over, when they changed jobs.


Overall, about a third of American households participate in 401(k)-type accounts, which hold a combined $3.5 trillion in assets. But a large portion of that money does not make it to retirement. A recent study by Boston College’s Center for Retirement Research found the typical household approaching retirement age has an average of $120,000 in retirement savings, enough for roughly a $7,000-a-year annuity.

‘‘401(k)s are not being used for retirement by a large and growing share of workers because they are misaligned with the very basic financial problems most workers face and must address,’’ said Fellowes, of HelloWallet.

Federal policy makers and employer retirement managers have focused little on the threat to retirement security posed by premature withdrawals and instead have worked to devise ways to get workers to put more money into the accounts at an earlier age.

In 2006, employers were given broader latitude to enroll employees in 401(k)-type plans unless workers asked not to participate. Just this year, the annual limit for 401(k)-type contributions increased from $17,000 to $17,500 for workers under age 50, and from $22,500 to $23,000 for those who are older. Meanwhile, the Saver’s Tax Credit provides up to $1,000 to help low-income workers build retirement savings.


Many employers have embraced 401(k) and other defined-contribution accounts as a way of helping workers save for retirement while relieving themselves of the financial risks that come with managing a traditional pension plan. In theory, 401(k) accounts are better suited to an economy in which workers are changing jobs more frequently than ever, because they can be rolled over from previous employers. But their success depends on workers consistently contributing to them and allowing the money to stay in place throughout their careers, allowing their investment returns to compound.

Generally, workers are allowed to tap their retirement accounts for loans up to $50,000, or half their account’s value, whichever is smaller. They also can ‘‘cash out’’ the money when they change jobs or they can take ‘‘hardship’’ withdrawals, which often go to pay for housing, overdue bills, or educational expenses. The cash outs and hardship withdrawals subject account holders to taxes on the money they put into the accounts, any investment gains, and if they are under 59½ years old, a 10 percent tax penalty.

Retirement experts warn that when workers draw on their retirement accounts to pay current bills, they put themselves at greater risk of descending into poverty upon retirement.

The widespread breaching of retirement accounts has led some advocates to conclude that policy makers and employers should expand their vision when thinking about their workers’ retirement needs.

Fellowes said workers would be better served by establishing emergency savings accounts that steered clear of the potential tax penalties, investment fees, and other risks and costs associated with having money in retirement accounts. Only after establishing an emergency savings fund, he said, should workers plow their money into retirement savings.