The data is in! More Americans are raiding their 401(k) accounts because of financial difficulties reports CNN. The most recent report from Bank of America released last Tuesday reveals that hardship withdrawals from 401(k)s increased 36% in Q1 of this year when compared to Q2 of 2022. The data was drawn from Bank of America’s analysis of their client’s employee benefits program which includes over 4 million plan participants.
Hardship Withdrawals
Hardship withdrawals can be taken for a variety of reasons including, purchasing a home, paying for educational expenses, and medical costs, or avoiding foreclosure or eviction to name a few.
The IRS defines a retirement plan hardship withdrawal as, a “distribution from a participant’s elective deferral account made because of an immediate and heavy financial need, and limited to the amount necessary to satisfy that financial need. The money is taxed to the participant and is not paid back to the borrower’s account.” Keep in mind that not all 401(k) plans include a hardship withdrawal provision. Even worse, these withdrawals cannot be repaid like a loan which means the plan participant has permanently reduced their account’s earning potential.
In part, hardship withdrawals are likely being fueled by inflation. As the cost of living surges consumers may opt to charge everyday expenses they once paid in cash. The New York Federal Reserve data shows that since 2019 overall household debt holdings have increased by $3 trillion while credit card debt exceeded $1 trillion for the first time!
A future retirement crisis for younger workers
Consequently, younger workers are likely to find themselves cash poor and hopefully house rich by the time they reach their 60s. But what about older Americans? Many have increased their systematic withdrawals from retirement savings to deal with the effects of inflation which substantially decreases the duration of their sustainable withdrawals- or how long that money will last. Others have chosen to work longer continuing to save and hoping the markets will be kind to their portfolio.
Accessing untapped home equity is not guaranteed
While this financial drama plays out millions of older Americans are sitting on, more precisely living in a substantial sum of home equity. Why do so few choose to even consider a reverse mortgage? One reason is many homeowners believe they will be able to tap into their home equity in the future should they need to. However, that strategy is risky at best. Lenders and banks routinely tighten their credit to consumers when economic conditions are uncertain or negative. Imagine the frustration when they learn that the value of their home is stuck in the bricks and mortar of their house unless they choose to sell. And despite what history has taught us most homeowners conveniently forget that their home’s value could drop, even significantly. How much of their home’s equity would be left then?
Facing the hard truth
So what can reverse mortgage professionals do? One is to understand the basic mechanics of retirement such as sustainable withdrawals, the distribution phase, required minimum distributions, and common pension benefits for surviving partners. Another key takeaway is to broach the question of how long their money will likely last. Some simple math can tell you roughly how long their current monthly distributions are sustainable.
You certainly don’t want to give financial advice, but you also don’t want to ignore the elephant in the room. Even better, partner with financial professionals in your market who know these metrics better than anyone and who are well-versed in approaching these sensitive discussions.
There’s no denying that Americans’ retirement is in disarray. The question is when will their largest asset be considered as a potential source of much-needed cash flow?
by Shannon Hicks August 21, 2023