The Wrongologist

What’s
Wrong Today:

Americans
have found a new source of spending money. After draining their home
equity lines and maxing out their plastic, some people have decided it’s time
to draw down their 401(k)’s. Bloomberg has a disturbing report that shows just that, using the
latest available data from 2011:

An earlier study by the Fed found that in
2010, 9.3% of taxpayers with retirement accounts or pensions were penalized, up
from 7.9% in 2004. As of March 31, the
median size of a 401(k) is $24,400, with people older than 55 having
$65,300 in their accounts, according to Fidelity Investments. These funds can be dissipated quickly
in retirement, and the early
withdrawals
indicate that the coming Boomer retirement crisis could be even more acute than
expected.

This
is not an unheard of phenomenon: As economic conditions deteriorate, withdrawals
have spiked in the past. They did in 1991, 2002 and 2007. The
inflation-adjusted IRS penalty cash collections declined 5% percent in 2011:

Source: Bloomberg

While
the graphic shows that penalties were slightly lower in 2011 than 2010, the fact that it’s higher than the levels
seen during the financial crisis years shows that economic stress is still high
in America.

Adjusted
for inflation, the government collects 37% percent more money from
early-withdrawal penalties than it did in 2003. Meanwhile, the amount of home-equity loans outstanding was $704 billion
in 2013, down 38% from the 2007 peak, according to the Federal Reserve data.

Bloomberg
quotes Reid Cramer, director of the Asset Building Program at the New America Foundation, which tries to improve savings for
lower-income families: (brackets by the Wrongologist)

Under
US law, money in tax-deferred retirement accounts can be removed without
penalty after age 59 1/2 and generally, you must start withdrawing after age 70
1/2. Withdrawals at any age are treated as income for the taxpayer and are
taxed at regular rates. The extra 10% penalty for 401(k) plans applies to early
withdrawals, except in cases of disability and certain medical expenses. And
think about the Fidelity statistics above: The
average 401(k) account for people over 55 holds just $65,300.

The
people who pay the penalty include younger workers who switch jobs and don’t
bother to roll over their accounts and older workers who have no place else to
turn. Here is a demographic breakdown of 401(k)s:

Source:
Bloomberg

Younger
workers ages 20 to 39 cash-out the most, with about 40% taking money with them
when they switch jobs, according to data from Fidelity. However, they take out
the smallest amount. Bloomberg quoted Michael Branham, a financial planner at
Cornerstone Wealth Advisors in Edina, Minnesota:

The
decreased income in retirement from making such a tradeoff is increasingly
damaging as Americans rely more on 401(k)-type accounts that they manage
themselves as opposed to pensions run by their employers. According to a Gallup
survey released May
2, 48% of non-retired Americans plan to rely on retirement accounts as a major
source of income, up from 42% in 2009, though down from a high of 54% in 2008.

And
take another look at the chart: People
in the 60-64 age group take out $36.4k, 2.4 times the average withdrawal,
and about 50% of what they have in the account.

Congress,
and others who are concerned about early withdrawals have two suggestions:
Lower the penalties, or raise them. (Thanks, Captain Obvious!) More restrictive
rules might prevent people from putting money in retirement accounts in the
first place, while lower tax penalties might make them more likely to take money
out of their accounts.

During
the 2008 campaign, Mr. Obama proposed allowing penalty-free withdrawals of up
to $10,000 from retirement accounts. That idea went nowhere and wasn’t included
in the 2009 economic stimulus.

Moving
in the opposite direction is House Ways and Means Committee Chairman Dave
Camp, (R-MI). In
his 2014 plan to revamp the US tax code, Camp proposed repealing the
penalty exceptions for higher education and first-time home purchases, contending that getting rid of the
exceptions would encourage Americans not to tap their retirement accounts early.

Maybe
this is understandable. The latest jobs report showed that the number of
long-term unemployed, measured as the level of people who’ve given up looking
for work and are counted as no longer in the workforce, continues to rise. We’re
also replacing middle class wage jobs with low end retail jobs and that trend shows
no signs of stopping.

So,
where are the jobs that will allow people to replace these drawn down savings? If
someone is already under economic stress, what do you think the odds are that she/he
will be able to repay the loan, particularly since it must be paid back with after-tax
dollars?

It’s
dispiriting to see economists and the financial pundits cheering the signs that
the economy is on the mend, that employment is better and consumers are regaining
their will to shop, at a time when plenty of people are needing to tap their
401(k)s to maintain their lifestyles. Financial advisors need to be able to reach a wider audience to talk about how this could affect their clientel. Going to websites like https://www.leadjig.com/financial-seminar-marketing/ can help them with strategies in this time of financial worry, so they are able to advise in the best possible way.

Withdrawals
which are required because of hardship shouldn’t incur a 10% penalty.

We need
to adjust our social and economic policies, or face up to the fact that the
401(k) piggy banks of many Americans are rocketing towards a brick wall.