Divorce Seen as Heavy Contributor to Early 401(k) Withdrawals

Compared to large purchases, Americans were more likely to take early withdrawals from their retirement accounts during a divorce or after losing a job, according to research by the University of Michigan. 

Mortgage payment distress was also a major factor leading families to withdraw funds, according to a working paper by economists Frank Stafford of the University of Michigan and Thomas Bridges of the University of Delaware.

The researchers found that divorced households are 9.5% more likely to access “fast cash” by cashing in retirement savings. They’re also 11.8% less likely to continue contributing to a retirement savings plan. What’s more, losing a job raises the probability of cashing in by 3.5%, while a 10% increase in out-of-pocket medical expenditures increases the probability by 0.6%. 

They note that this number could change with people losing their jobs—and their health insurance—during the 2020 coronavirus outbreak. “From our work, we expect to see heavy access to pre-retirement pension balances, and ceasing to participate in contributing to pension in response to the economic impacts of coronavirus,” says Stafford. “We also expect to see lower incomes, housing payment problems, family dissolution and divorce.”

The researchers’ assessment was based on the connection between retirement saving and current income and consumption in light of the transition from DB to DC plans. Stafford notes that this shift resulted in a greater share of households with access to liquid retirement savings, as well as a greater share of households whose retirement security depends on voluntary contributions.  

To determine whether employees accessed funds from their retirement accounts and under what conditions, the study used data from the Panel Study of Income Dynamics, which has followed the same families and their descendants since 1968. Stafford and Bridges sampled the nine survey waves that include wealth and pension data from 1999 to 2015. Within that subset, the authors further restricted their sample to married households aged 25 to 64, though the participants did not need to remain married throughout.

Households in which the head is aged 62-64 were most likely to cash in from their retirement accounts, followed by the age brackets 59-61 and 44-58.

On a positive note, the researchers did not find that homeowners were cashing in their retirements or reducing their contributions in order to remodel their homes or make other large purchases. “This suggests that families are less willing to use their pensions savings as a ‘convenient ATM’ for discretionary durable purchases,” according to the researchers.

In fact, they found that large household purchases meant that people were more likely to contribute to a household retirement savings account. What’s more, people who received windfalls such as inheritances of more than $10,000 were also 4% more likely to continue their contributions.

While the flexibility of direct contribution retirement accounts can help people in financial distress, borrowing from one’s retirement account now could have financial repercussions down the line. “There is the short-term benefit of greater liquidity through reducing contributions to, or withdrawing cash from, retirement resources, and this liquidity feature may substantially benefit constrained households,” Stafford says. He adds that, “Of concern, however, is the effect of repeated use of these more flexible retirement account saving features on longer term savings adequacy.”