Strained Personal Finances: The Impact of the Pandemic, Inflation, and Turbulent Stock Market

The ongoing pandemic, coupled with rising inflation and a volatile stock market, has significantly affected personal finances. As a result, more than one-third of workers find themselves compelled to dip into their 401(k) accounts before retirement.

According to a recent report released by the non-profit organization Transamerica Center for Retirement Studies (TCRS), in collaboration with Transamerica Institute, an alarming 37% of workers have resorted to taking a loan, making an early withdrawal, or facing a hardship withdrawal from their 401(k) or similar retirement plans, such as an IRA. This figure includes 30% of individuals who have taken out a loan and 21% who have initiated an early and/or hardship withdrawal.

While the overall statistic stands consistent with last year’s survey results, TCRS highlights the fact that the percentage has witnessed a slight increase from the previous year’s response rate of 34%.

Catherine Collinson, the CEO and President of Transamerica Institute and TCRS, acknowledges the profound impact of the pandemic and economic turmoil on workers’ employment, finances, and retirement preparations. She emphasizes that without additional support from policymakers and employers, many workers will face extreme difficulty in recovering from their financial setbacks.

Amidst the prevailing circumstances, Collinson sheds light on the precarious financial situation faced by many workers who find themselves juggling competing priorities. These include covering basic living expenses, paying off debts, and attempting to save for the future. Unfortunately, only a minority of workers have managed to set aside sufficient emergency savings.

To navigate these unprecedented challenges and assist workers in rebuilding their financial resilience, it is imperative for both policymakers and employers to step up and provide additional support. By doing so, they can help alleviate the strain on workers’ personal finances and contribute to a more secure and stable future.

The Consequences of Dipping into Retirement Accounts

As many workers face financial shocks, their options for dealing with these situations may be limited. In some cases, individuals resort to taking on high-interest rate credit card debt, while others turn to their retirement accounts for immediate relief. However, this short-term solution can come with significant long-term consequences.

According to the Internal Revenue Service, withdrawing funds from a retirement plan before the age of 65 (or the plan’s normal retirement age) can result in an additional income tax of 10% of the withdrawal amount. This means that not only will individuals have to pay taxes on the withdrawn amount, but they will also incur penalties.

Moreover, by prematurely tapping into retirement savings, individuals miss out on the potential growth and compound investment returns over time. Ultimately, this can significantly hinder the long-term growth of their savings and reduce their overall nest egg.

A recent study by TCRS reveals that almost one in five workers have taken a loan from their retirement accounts. Of those, 10% are currently paying back the loan, while 8% were unable to repay it. Surprisingly, Generation Z, with 28%, is more likely to take early and/or hardship withdrawals compared to millennials (24%), Generation X (19%), and baby boomers (12%).

When asked about the reasons behind taking a loan from their retirement accounts, a financial emergency was the most frequently cited reason (31%). Other common motives include paying off debt (30%), such as credit card debt (29%) or other debt (1%). Additionally, everyday expenses (26%), medical bills (25%), home improvements (23%), vehicle purchases (19%), and unplanned major expenses (19%) were also mentioned.

It is crucial for individuals to consider alternative options before resorting to dipping into their retirement accounts. Seeking financial advice and exploring available resources can help individuals navigate through challenging times without compromising their long-term financial security.

Financial Challenges of Different Generations

Introduction

In today’s economic landscape, various generations face different financial challenges. Recent studies have shed light on the specific concerns faced by Gen Z, millennials, Generation X, and baby boomers. Understanding these challenges and finding suitable solutions is essential for effectively managing personal finances.

Medical Bills: A Mounting Concern

Among all the generations, medical bills emerge as a significant concern for Gen Z workers. Surprisingly, one in three Gen Z workers (33%) reported being burdened by medical expenses. The percentage for the other generations varies, with millennials (33%), Generation X (26%), and baby boomers (21%) following behind.

Home Improvements: Incurring Expenses

Interestingly, both millennials and Gen Z individuals face the challenge of home improvements. One in four millennials (28%) and Gen Z (28%) find themselves incurring expenses related to enhancing their living spaces. On the other hand, only 17% of Generation X and 14% of baby boomers reported similar concerns.

Tapping into Retirement Accounts: A Possible Solution

To alleviate financial burdens, some individuals might consider withdrawing from their retirement accounts. However, before taking this step, it is crucial to carefully evaluate all options. According to expert advice, borrowing from a 401(k) plan is preferable to a hardship withdrawal or early withdrawal.

Repayment Strategy for Loans

If you opt for a loan from your retirement account, ensure that you have a solid repayment strategy in place. It is important to avoid the potential pitfall of defaulting on the loan when separating from an employer. Typically, if the loan is not repaid in full within a relatively short period, it will be re-characterized by the IRS as an early withdrawal. This re-characterization can result in taxes and potentially a 10% penalty if you are under the age of 59½.

Reasons for Hardship Withdrawals

While borrowing from a retirement account is an option, some individuals might resort to hardship withdrawals. The reasons for taking such withdrawals from a 401(k) or similar plan vary. Some common reasons include:

1. Paying for medical expenses (17%)
2. Preventing eviction from one’s principal residence (16%)
3. Covering expenses and losses due to a federally declared disaster area (15%)
4. Payment of tuition and related educational fees (14%)
5. Costs related to the purchase of a principal residence (13%)
6. Funding qualified repairs to damage in a principal residence (12%)
7. Burial or funeral expenses (6%)

It is worth noting that hardship withdrawals can only be made if there is an immediate and heavy financial need, according to the IRS.

Conclusion

Understanding the financial challenges faced by different generations is crucial for devising effective strategies to manage personal finances. Whether it’s dealing with medical bills, home improvements, or considering tapping into retirement accounts, individuals must carefully evaluate each option and have a clear plan in place to navigate these challenges successfully.

Retirement Savings and the Impact of Hardship Withdrawals

In the first quarter of 2023, Bank of America reported a significant 33% increase in the number of people resorting to hardship withdrawals from their retirement accounts compared to the same period the previous year. On average, each worker withdrew approximately $5,100 during this time.

The current financial landscape has created a worrisome situation, with individuals facing numerous competing financial priorities. The imminent end of pandemic-related relief programs, the persistence of inflation, and the uncertain labor market all contribute to the growing concern. Patty Collinson, an expert in the field, voiced her apprehension about the short-term consequences of these factors.

Moreover, Collinson expressed particular concern for younger workers in their 20s and 30s. She pointed out that these individuals might not have the necessary cash flow to resume their student loan payments, especially if they were depending on a forgiveness program that may or may not come to fruition.

Despite these immediate worries, Collinson holds a more optimistic outlook for the long-term trend. She predicts that as people become more aware of the importance of building emergency savings, the number of individuals resorting to tapping their retirement accounts will begin to stabilize.

Taking a forward-looking approach, the recently passed SECURE 2.0 legislation aims to address this issue. The legislation introduces an emergency savings account as a new plan feature for defined-contribution retirement plans, including 401(k) plans. This measure is designed to mitigate the need for workers to retrieve funds from their retirement savings. Additionally, SECURE 2.0 offers relief from the 10% early withdrawal penalty under certain conditions.

Collinson believes that while these provisions may not completely discourage early withdrawals, they will certainly lessen the financial consequences for those who find it necessary to resort to them.

In conclusion, the rise in hardship withdrawals from retirement accounts raises concerns regarding individuals’ financial stability in the face of various challenges. However, with greater awareness and the implementation of initiatives such as the emergency savings account under SECURE 2.0, there is hope for a more secure future that allows workers to build their retirement savings while safeguarding against unexpected financial difficulties.