More raid retirement accounts to pay bills

More than one in four Americans use 401(k) for current expenses

The Washington PostJanuary 19, 2013 

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300 dpi Gabi Campanario illustration of a person climbing a ladder toward a giant basket filled with eggs labeled 401K. Seattle Times 2009

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— A large and growing share of American workers is tapping 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 federal policymakers eyeing cuts to Social Security benefits and Medicare to rein in soaring federal deficits, and traditional pensions in a 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 recent report from the financial advisory firm HelloWallet found that more than one in four workers dip into retirement funds to pay their 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 they also pay income taxes. The costs are financially harmful to families even as money-management firms reap massive fees for handling retirement accounts that ultimately are not used for retirement.

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

“What you have is 401(k) participants voting with their wallets, saying they would much rather use this money for other purposes. 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 chief executive of HelloWallet. “In many cases, the only one benefiting is the vendor.”

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

“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 who studies retirement policy .

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. The withdrawals have grown substantially in the wake of the financial crisis.

In 2010, 28 percent of participants reported having outstanding loans against their retirement accounts, an all-time 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 rolling 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. But a lot 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 about 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,” Fellowes said.

Federal policymakers and employer retirement managers have focused little on the threat to retirement security posed by premature withdrawals of savings, and instead have worked to devise ways to get workers to put more money into the accounts at earlier ages.

401(k) enrollments

In 2006, employers were given broader latitude to enroll employees in 401(k)-type plans unless workers asked not to participate. This year, the annual limit for 401(k)-type contributions increased from $17,000 to $17,500 for workers younger than 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 traditional pension plans. In theory, 401(k) accounts are better suited to an economy in which workers are changing jobs more frequently than ever because the accounts can be rolled over from previous employers.

Impoverished seniors

But their success depends on workers consistently contributing to them and letting the money stay in place throughout their careers, allowing their investment returns to compound. Many workers – particularly some earning higher salaries – do just that. But many others, who have precious little savings elsewhere, tap their retirement money as a sort of “rainy day” fund, eroding its power for the future.

Generally, workers are allowed to tap their retirement accounts for loans of as much as $50,000 or half their account’s value, whichever is smaller. They also can “cash out” when they change jobs, or they can take “hardship” withdrawals, which often go to pay for housing, overdue bills or education expenses. Cash-outs and hardship withdrawals subject accountholders to taxes on money put into the accounts, and investment gains, and if they are younger than 59-1/2, a 10 percent tax penalty.

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, which would leave them dependent on government programs such as subsidized housing or food stamps. Nearly 6 million senior citizens were living in or near poverty in 2010, according to a Senate committee. The number is expected to increase sharply over the coming decade after a long period of decline.

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