Hardship withdrawals are hard for everyone 

An employee just got off a difficult phone call with their mortgage lender - they can’t afford their monthly payment for the third month in a row. They’re frustrated and more than likely, ready to do whatever it takes to keep their home. Their next call is to your client’s HR department.

HR professionals are overwhelmed with calls like this; their employee wants to take a hardship withdrawal from their retirement plan and they could use some help communicating the consequences of pulling from one’s retirement plan, along with the backlash they get when employees eventually get their tax bill.

But it’s not just HR that hardship withdrawals and loans hurt. For the participant, it means a possible and often unexpected tax bill next year. For you, it means depleting your plan’s assets.

Unfortunately, participants’ pulling from their plans is becoming more common. Since the beginning of 2009, calls to our financial helpline about hardship withdrawals and loans increased from 9 percent to 18 percent. Only 3 percent of employees who called had questions on investing and questions about increasing plan contributions were virtually non-existent. This tells us the last thing on employees’ minds is increasing their plan contribution. So what can you do about it?

Even though HR can feel like the bearer of bad news for any employee taking a withdrawal from their plan, they can use this opportunity to help their employees understand how it affects their retirement. You can help protect your plan assets by putting together a hardship toolkit or checklist for your clients’ HR departments that will help them deliver beneficial information.  Include the following tools and tips:

• Consider more liquid resources. A hardship withdrawal should be a last resort. HR can help employees by asking them if they’ve looked into every other possible avenue for the funds before tapping their retirement.
• Use this time to build an emergency fund. Many times, employees often have to suspend contributions to a 401(k) after taking the hardship so this is a good time to build an emergency fund instead.
• Offer a retirement calculator. Give HR a retirement savings calculator they can easily send to their employees so they can ensure they are able to rebuild their retirement after they take the withdrawal.
• Suggest they withhold taxes at the time of distribution so they aren’t hit with a tax bill when they file for the year. This is often overlooked and HR receives most of its calls from frustrated employees because the employee simply didn’t realize they would incur these taxes later on. 

Providing a resource like a hardship toolkit is invaluable to your client’s HR team.  Even when times are hard and participants’ focus is on the monthly bills, you can help by offering resources they can use to get back on track and become more proactive about future decisions to pull from their plan. You may not be the one getting the frustrated call directly this tax season, but the best way to protect your company’s asset base is to do something to help make sure HR doesn’t get as many of them.

• • 11/30/2009 9:36:42 AM
  • BenefitJack
  • Loans
  • You state: "... But it’s not just HR that hardship withdrawals and loans hurt. For the participant, it means a possible and often unexpected tax bill next year. For you, it means depleting your plan’s assets. ..." Absolutely wrong with respect to loans. Why do you deliberately mislead readers by lumping loans in with hardship withdrawals? STOP. First, properly executed, a loan does not generate any tax consequences: (a) The transaction is not taxable, and (b) The nature of the underlying principal is not affected. Second, a loan does not reduce plan assets: (a) Assets remain in the plan, temporarily recorded as a different form of investments, and (b) Loan principal must be repaid with interest - rebuilding the account for a future use. Third, studies show that loans that are repaid (where contributions continue otherwise unchanged), can actually increase account balances and improve retirement preparation. See studies by: (a) Geng Li & Paul Smith, which concluded: "... we estimate that such households could have saved as much as $5 billion in 2007 by shifting expensive consumer debt to 401(k) loans...." http://www.federalreserve.gov/pubs/feds/2009/200919/200919pap.pdf, or (b) Beshears, Choi, Laibsen, Madrian, who state "... Although the popular press and politicians often describe 401(k) loans as a problem, classical economic theory has a more benign view. Loans from a 401(k) can relax liquidity constraints and increase household utility. Moreover, loan provisions may have the subtle effect of raising net asset accumulation by making 401(k) participation more appealing: employees who can access their 401(k) assets if they need them may be willing to put more money into an otherwise illiquid 401(k) account. Our research suggests that 401(k) loans are neither a blessing nor a bogeyman...." http://www.nber.org/programs/ag/rrc/08-09%20Beshears,%20Choi...FINAL.pdf Simply, when you lump loans with withdrawals, you mislead your readers and do everyone a disservice. STOP. If you want to help your readers, suggest that there is much to be improved for most 401(k) plans in terms of "21st Century loan repayment processes" - to ensure not so much easy access to money, but to make loan repayment so easy as to become a near certainty.
• • 12/4/2009 4:05:52 PM
  • Danielle Perry
  • RE: Loans
  • BenefitJack, you are right. A hardship withdrawal has tax consequences that a loan does not and the way the blog is written, it does lump them together. To clarify, a hardship withdrawal triggers a taxable event, depletes a plan's assets, and can possibly derail the participants retirement goals. A loan does not necessarily trigger a taxable event and the employee pays the loan back through payroll deduction. What this blog aims to point out, is that loans hurt as well. They hurt because the employee has to take them in the first place. The premise is to help plan sponsors encourage employees to not tap into their 401(k) for everyday living expenses and emergencies. This is how loans negatively impact employees. A loan can also turn into a withdrawal if the employee is laid off or leaves their place of employment. If they can't pay it back, it becomes due and payable -- and taxable. Ultimately, that can hurt.
• • 12/28/2009 9:18:25 AM
  • BenefitJack
  • Loans
  • But, and the point really is, a loan from a 401(k) need not hurt any more, and may, in fact, hurt less than a loan from a commercial source. You have to save first. Then you borrow from your own "bank". Isn't that actually something to encourage?