Rate of 401(k) Hardship Withdrawals Jumps

Amid a weakening economy and rising layoffs, the percentage of 401(k) plan participants who have made hardship withdrawals from their accounts jumped 21 percent during the first six months of 2008 compared with the same period last year, according to Mercer. During the same period of time, the number of new loans taken out by plan participants increased 4.5 percent.

The trend concerns retirement plan consultants because it might indicate that employees aren’t exhausting all of their options before making hardship withdrawals.

“Usually you would see people take out loans first and then go to a hardship withdrawal,” said Eric Levy, worldwide partner, retirement business leader at Mercer.

The fact that the rate of hardship withdrawals has exceeded the rate of new loans might indicate that many of these employees have maxed out their loans, and thus have to rely on hardship withdrawals, said Mike Kushner, an ERISA attorney with New York-based Curtis, Mallet-Prevost, Colt & Mosle. By law, 401(k) plan participants can take out a loan of $50,000 or 50 percent of their vested balance.

A lot of the participants who are making hardship withdrawals could be terminated employees. Such employees can make hardship withdrawals, but can’t take out loans, Levy notes.

This trend could also be a sign that 401(k) plan administrators aren’t doing a good job of making sure that participants have maxed out their loans before making hardship withdrawals, said Don Stone, president of Plan Sponsor Advisors, a Chicago-based consultant.

“I am not sure all of the vendors are tracking this and that employers are paying attention to it,” he said.

The increase in hardship withdrawal requests from plan participants has likely put a burden on many plan administrators, Kushner said.

“It’s a sizable burden,” he said, noting that administrators have to interpret plan documents, make sure the rules are being applied uniformly and that participants don’t have other assets readily available. “There are a number of things that might not have been tracked as tightly as they should have been in the past because it didn’t come up as often,” he said.

To ensure that these transactions are being handled correctly, employers need to stay in touch with their administrators and double check any requests for hardship withdrawals, experts say.

While the number of hardship withdrawals has jumped, it still represents only a small percentage of the plan participant population, Levy noted. Two percent of plan participants have made hardship withdrawals, according to Mercer.

Employers might also want to do additional education and counseling on the implications of hardship withdrawals, Levy said.

For example, if plan participants make withdrawals before they are 59½, they will have to pay income taxes and a 10 percent penalty within the next year.

Depending on how much money they are taking out, that sum could push the employee into a higher tax bracket, Levy said.