401(k) Balances Are Way Up. But Withdrawals Have Reached Record Levels

It was the best of times, it was the worst of times.

The stock market and peoples’ retirement savings may be up, but that doesn’t mean inflation and day-to-day expenditures are any less painful. Last year, the S&P 500 climbed more than 16%, and average retirement account balances increased 13%, according to Vanguard data. Yet a record 6% of workers with Vanguard accounts withdrew from their 401(k)s, up from 5% the previous year. It’s an unfortunate reality for many retirement savers because as much as they feel unprepared for retirement, they’re also worrying about  the here and now. It’s also an opportunity for advisors to step in.

“People are looking everywhere, every possible corner, for money, and the 401(k) is probably one of the worst places to find it,” said Ed Slott, a CPA and longtime retirement planning expert.

Catch-22

Pulling money from a 401(k) is widely considered a last resort. Early withdrawals often trigger taxes and penalties, and participants lose the long-term benefits of compounding. “A lot of workers are seeing their retirement accounts go up on paper while their monthly cash flow is getting tighter,” said Daniel Milks, founder of Woodmark Advisors, adding that housing, insurance and childcare costs are rising faster than wages. “When budgets get squeezed, the 401(k) can start to look like the only accessible pool of money.” 

The Vanguard report also found:

• The median withdrawal amount last year was $1,900, and the median account balance was just over $44,000.
• Roughly two-thirds of plans that offer automatic enrollment set default contributions at 4% or higher, and the bulk of them include annual automatic escalation.

So where should clients go when they’re in need of cash? There isn’t really a good answer, just less worse ones. Options include taking out a loan from their 401(k) and repaying it later, or reducing their contributions temporarily, but both can slow retirement progress. “If you do need emergency money, I hate to say it, but the best place is probably the Roth IRA,” Slott said, pointing to how contributions can be withdrawn at any time tax- and penalty-free.

Keeping Up with the Joneses: There’s also a behavioral element to savers withdrawing early, argued Ryan Marshall, a CFP with Cetera Advisor Networks. “Social media creates the impression that everyone is traveling, renovating homes, or living large,” he told Advisor Upside. “The reality is most people cannot afford that lifestyle, but some try to keep up.”

Plus, automatic plan enrollment and legislation in the past few years have made it easier for workers to access hardship withdrawals. That convenience can come with a cost. “Once someone taps their retirement account, it becomes psychologically easier to do it again,” Milks said. “The account shifts from being viewed as ‘retirement money’ to ‘emergency money,’ which can derail long-term planning.”