Tuesday, February 12, 2013

Americans Borrowing From the Future?

Charles Delafuente of the NYT reports, Borrowing From the Future (h/t, Suzanne Bishopric):
Early withdrawals from 401(k) and 403(b) retirement accounts can have significant effects on a nest egg. Even borrowing against those accounts can stunt their growth.

And yet a new study shows that more than one out of four households dips into such accounts — sometimes emptying them out — often with significant future consequences.

The study, by HelloWallet, shines a spotlight on the issue and offers an unorthodox prescription for some employees with financial problems: they shouldn’t participate in an employer’s 401(k) program until they have sufficient emergency savings.

Financial planners use different amounts for that emergency fund. HelloWallet defines it as savings equal to three months’ income. Without that, the report said, “an economic shock, such as a car maintenance or health problem, may force the household to breach their retirement savings.” And, it added, “Insufficient emergency savings has the strongest association with breaching that we find.”

The study, published last month, focused on workplace-based plans, primarily 401(k) and 403(b) plans. It did not look at Individual Retirement Accounts, which are also retirement savings and can be invaded before retirement, with penalties.

The report, “The Retirement Breach in Defined Contribution Plans,” found that withdrawals for nonretirement purposes by account holders under 60 amount to $60 billion a year, or 40 percent of the $176 billion employees put into such accounts each year and nearly a quarter of the combined $294 billion that workers and employers contribute.

The study found that another $10 billion leaked out of 401(k) and 403(b) plans through loans when employees borrowed against their accounts.

HelloWallet’s chief executive, Matt Fellowes, called that combined $70 billion a “shocking figure” and expressed dismay that it was increasing at a faster rate than overall contributions were increasing.

He described HelloWallet as “a technology-based financial guidance software application.” It is distributed, he said, “by very large employers who provide it as a workplace benefit” to employees, who use it to get financial planning advice online. HelloWallet’s service can be purchased on its Web site. But it does not advertise for or seek individual customers, he said.

He said the study could not determine what amount or percentage of an account the average premature withdrawal involved because data was limited, but that the authors did know that the median 401(k) account had less than $17,000.

The analysis, based on surveys by the Federal Reserve and the Census Bureau, found that nearly three-quarters of those who took a premature full distribution from a retirement account did so because of “everyday basic financial management problems, from trouble paying bills to general expenses that they feel like they cannot keep up with.” Only 8 percent cited joblessness, and only 6 percent “frivolous” reasons like a vacation or a purchase.

The study found a correlation, not surprisingly, between household income and early withdrawals; 35 percent of households with less than $50,000 in annual income went into a retirement account prematurely, but only 12 percent of those with incomes over $150,000 did so. It also found higher rates of early withdrawals among black and Hispanic workers than white ones. And it found that people age 40 to 49 were most likely to make premature withdrawals, followed by those 50 to 59. Those who seek to tap their retirement funds must comply with Internal Revenue Service regulations and the rules of the employer that sponsors the plan.

The I.R.S. allows withdrawals only in the event of hardships, which are defined by each plan. They often include looming foreclosure or significant medical expenses. The rules are complicated because every plan is unique, Mr. Fellowes said, and there are gray areas about what constitutes a hardship. The I.R.S. has added expenses like college tuition and up to $10,000 to buy a first home to the list of allowed withdrawals.

Withdrawals are limited to half of an account, to a maximum of $50,000 for accounts of $100,000 or above, Mr. Fellowes said. But those limits do not apply to ex-employees. Someone who leaves a job, or loses one, can withdraw the entire balance.

Withdrawals, whether while still employed or not, come at a stiff cost. Whatever is taken out is subject to income tax, unless it is taken from one of the new Roth 401(k) or 403(b) accounts. Withdrawals are also subject to a 10 percent early withdrawal penalty, according to the I.R.S., if the account holder is younger than 59 1/2 (or, for ex-employees, younger than 55 or totally disabled) unless they are for high medical expenses, higher-education costs or a new home. Withdrawals from some Roth rollover accounts are not subject to the penalty. HelloWallet estimated that 85 percent of withdrawals were subject to penalties.

Taxes and penalties are one reason an employee with no financial cushion should consider creating an emergency savings account before contributing to a retirement plan. Another reason, the report said, is that retirement plans “come with a hefty set of unnecessary fees and inappropriate investment choices for many workers.”

Mr. Fellowes said that not investing in a retirement plan until a worker had an emergency fund might be wise even if the employee lost an employer’s matching contributions. One reason, he said, is that matches usually do not vest immediately, so they are not available to be withdrawn.

Noreen Perrotta, the editor of Consumer Reports Money Adviser, was somewhat uneasy with opting not to contribute. “I would be reluctant to advise someone not to put money into a retirement account,” she said. “Our advice is that they should contribute at least up to the match,” although she said that advice might not apply to someone with no financial cushion at all.

An alternative for the cushionless, she said, could be to put money into a Roth I.R.A., because there is no penalty for withdrawing principal from it.

Taking a loan from a retirement account might not seem as drastic a step as taking money out of it, especially because the interest the borrower pays goes back into the account, along with the principal as it is repaid, and there are no taxes or penalties if the repayments are on time.

But loans can still sharply affect a retirement account, Mr. Fellowes said.

He said borrowers typically did not make new contributions to their retirement plans while paying off loans — usually over five years — so the total amount contributed is reduced. Only the most disciplined borrowers make new contributions while also paying off a loan from the plan.

“You’re taking money out of a long-term investment,” Mr. Fellowes explained. “You take a big cut against retirement security because you lose the benefit of compounding over time.”
You can read HelloWallet's entire study by clicking here. As you can see, America's 401(k) nightmare is far from over. A lot of people desperate for money were forced to dip into their retirement account.

Go back to read my last comment on the pension fund that ate California where I ended it off with some observations from Suzanne Bishopric, Director of Investment Management Division at the United Nations Joint Staff Pension Fund, who sent me the article above:
EVERYBODY envies public pensions, except in Canada, because the various individual schemes launched elsewhere are proving to be inadequate. South of the border, the baby boomers were sold a bill of goods when they bought into the self-directed IRA plans. It appealed to the young baby boomers to "do their own thing" and have "control" over their money. The financial community loved it. The atomized nature of the personalized pensions meant the banks and brokers were able to earn retail rates on what had been managed on a pooled, wholesale, basis by pension funds.
Sadly, the contributions to the IRA's and 401(k)s were not adequate, nor was investment acumen demonstrated by most first-time investors. No training was given before the responsibility for portfolio management was handed over to a generation of workers. Add to that the volatility of the markets since 1986, and the results on average have been poor (for many professionals, as well). What is worse, many desperate unemployed baby boomers raided their IRA's or borrowed against their 401k's to tide themselves over, when faced with housing or medical bills. To top it off, no one planned for the reality that after age 80, only about half of individuals can balance a checkbook. How does a sick person continue to manage investments in such an environment, with "safe" investments yielding zilch?
Even worse, there are many very healthy 80+ year old people who will outlive their meager savings, since individual retirement accounts have no provision for insurance against longevity risk. Social Security payments are a small palliative, assuming that the next generation of workers continues to foot the bill. The era of impoverished retirements is about to begin, south of the border.
As I stated, we should listen to real pension experts like Suzanne Bishopric and others who are sounding the alarm on America's retirement crisis and figure out ways to bolster defined-benefit plans for public and private workers, not vilify public sector workers for having what everyone deserves, namely, secure pension benefits allowing them to retire in dignity.

By the way, the situation in Canada is better but there is trouble ahead. Although we don't have studies on RRSP withdrawals since the crisis, we know that Canadians aren't saving enough for retirement and that the majority of them say they plan to invest in a retirement plan this year, but many won’t follow through on those good intentions

Below, a clip from a 60 Minutes report on the 401(k) fallout which first aired in April 2009 discussing another problem, the hidden fees in these individual retirement plans and how retail investors are getting raped on fees. As I've stated, we all need a reality check on pensions. Think 60 Minutes needs to revisit this topic.

Also embedded a 2009 clip of CBS MoneyWatch.com editor-in-chief Eric Schurenberg discussing why 401(k) plans don't work. Listen to his comments carefully, he's spot on.