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Nov. 12, 2019, 11:05 a.m. EST

It’s going to be easier to make early 401(k) withdrawals, but should you do it?

Why experts urge caution tapping retirement money before you retire

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By Chris Farrell

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3 ways 401(k) early withdrawals will get easier

Here are the three ways the early-withdrawal rules are changing come January 2020:

  • Under the old rules, hardship withdrawals were limited to the amount of money you’d contributed into the plan. The new rules increase the potential pool of savings by including any employer match, profit-sharing contributions and investment earnings.

  • Employers will no longer require you to take out a 401(k) loan before applying for a hardship withdrawal.

  • You’ll be allowed to contribute to your 401(k) immediately following the withdrawal, rather than waiting six months, as in the past.

What retirement experts expect

“My take is that more employees will be inclined to take hardship withdrawals, with employer matches and investment earnings now becoming accessible,” says Olivia Mitchell, professor of insurance and risk management at the Wharton School and executive director of the Pension Research Council.

The reason hardship withdrawals and loans are allowed: there’s some evidence that knowing the possibility of dipping into retirement savings exists boosts both participation and savings rates.

The new rules might boost the popularity of hardship withdrawals over loans.

A 2017  study of 401(k)s by Mitchell and colleagues found that 86% of 401(k) loan defaults occur when an employee failed to pay the money back within the required six months after leaving. Here, “default” means the amount outstanding is considered an early withdrawal and hit with a 10% penalty and income taxes.

“If there is a substitution of hardship for regular plan loans, this could reduce the unpleasant surprise when people leave their jobs and find they need to come up with money to pay the tax plus, possibly, a penalty for not repaying the loan,” Mitchell says.

The big worry: 401(k) leakage

The big worry is that the making hardship withdrawals easier will increase what’s known as 401(k) “leakage” — meaning people using their retirement plan money while employed.

Already, 401(k) leakage is considerable and concerning.

Participants in 401(k) plans aged 25 to 55 withdrew at least $29.2 billion early as hardship withdrawals, lump sum payments made at job separation (known as cashouts) and unpaid loan balances in 2013, according to a March 2019  Government Accountability Office report on 401(k) plans. That amount is actually understated since data limitations obscure the total amount of unpaid 401(k)s loans.

According to an  Employee Benefit Research Institute analysis , eliminating leakage would result in roughly 27% more participants achieving “retirement success” for the lowest quartile of them based on income. For the highest income quartile, an additional 15% would reach their retirement benchmark, EBRI estimates.

How to limit leakage

Retirement analysts have a number of good ideas to reduce 401(k) leakage: Simplifying the rollover process when employees change jobs; narrowing the reasons for hardship withdrawals to exclude buying a home and paying for postsecondary education and incorporating an emergency savings account within a 401(k) plan. For an explanation of the last idea, see the Next Avenue story, “ The Sidecar Plan to Help Workers Save for Emergencies .”

Meanwhile, with the new hardship rules, the government’s essentially encouraging people to make early withdrawals from their 401(k)s.

Of course, financial emergencies happen. Just remember, if you take a 401(k) hardship withdrawal, you’ll have less money set aside for retirement — when you probably could really use the cash.

Sometimes, an early withdrawal is the right choice to make. But only sometimes.

Chris Farrell is senior economics contributor for American Public Media’s Marketplace. An award-winning journalist, he is author of “ Purpose and a Paycheck: Finding Meaning, Money and Happiness in the Second Half of Life ” and “Unretirement: How Baby Boomers Are Changing the Way We Think About Work, Community, and The Good Life.” @cfarrellecon

This article is reprinted by permission from NextAvenue.org , © 2019 Twin Cities Public Television, Inc. All rights reserved.

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