A recent report contends that changes enacted under the Bipartisan Budget Act (BBA) of 2018 have led to a noticeable jump in withdrawals.
The white paper from Fidelity Investments – “Hardship Withdrawals: Improving the well-being of those who take them” – explains that since passage of the BBA the firm has seen a shift in participant behavior.
The BBA eliminated the requirement that a participant must first request all available loans before taking a hardship withdrawal. It also called for eliminating the six-month suspension period for making 401(k) contributions following a safe harbor hardship distribution, as well as expanding the types of funds that can be distributed under a hardship withdrawal to include QMACs, QNECs, 401(k) safe harbor plan contributions and earnings.
Fidelity’s report notes that while the percentage of participants taking loans and hardships overall has not increased, of those withdrawing money from their plan, fewer are taking loans and more are taking hardships. Based on Fidelity data from more than 33,000 plans with 23 million participants as of June 30, the firm projects that the annual loan rate for 2019 will dip slightly to 9.2%, while the annual hardship rate will rise to 4.4% – up from about 3% in 2018 and an average rate of 2.2% since 2009. The firm projects that its current findings for 2019 will likely hold true for the remainder of the year.
Sean Dungan, Director of Data Analytics and Insights at Fidelity, explains that the trend toward more hardship withdrawals and less loan activity since the BBA was enacted is clear and accelerating slightly. Dungan notes that Fidelity “saw the increase in week one of this year and over the summer it has not slacked off.” Dungan adds that the firm is “not seeing a perfect shift” between hardship withdrawals and loans, but maintains that there has been a clear inverse relationship.
While Fidelity’s data does show an uptick in hardship withdrawal activity for 2019, it’s also important to remember that these changes under the BBA only just became effective (for plan years beginning after 2018) and only for plans that actually permit hardship distributions.
Longer term, those changes may be further aided by proposed regulations issued by the IRS in November 2018 addressing changes in the BBA that modified the safe harbor list of expenses for which distributions are deemed to be made on account of an immediate and heavy financial need, including:
- clarifying that the home casualty reason for hardship does not have to be in a federally declared disaster area (an unintended consequence of the Tax Cuts and Jobs Act of 2017); and
- adding expenses incurred as a result of certain disasters for which the IRS and Congress have traditionally, but separately, provided relief in the past, such as hurricanes, tornadoes, floods and wildfires – including, for example, Hurricanes Michael and Florence in 2018. The IRS explained that this was intended to eliminate any delay or uncertainty concerning access to plan funds following a disaster that occurs in an area designated by FEMA.
Hardship Reasons?
Fidelity’s paper emphasizes that although the overall rate of hardship withdrawals remains low historically, of those who do take them, 73% do so for one of two main reasons: to prevent eviction or foreclosure or to pay uninsured and unreimbursed medical expenses. For both hardship reasons, the average amount is $2,900 and the average number of withdrawals taken per participant is 1.5 per year, according to the firm’s data.
The percentage breakdown for hardship withdrawal reasons for 2019 includes:
- foreclosure/eviction (42%);
- medical (31%);
- education (13%);
- home purchase/repair (12%); and
- funeral (1%)
The report does not break down, for example, how much of these withdrawals were related specifically to disaster-related spending or perhaps someone tapping their 401(k) to pay for a first home.
But to that point, Dungan notes that hardship withdrawals in essence “become fungible” for someone who is struggling, such that they may be able to pay their mortgage but then can’t pay their medical bills. Dungan notes that Nevada has seen the highest rate of hardship withdrawals, but adds that states such Texas, Florida and Alabama have also seen high rates.
The good news, according to Fidelity, is that since enactment of the BBA, plan sponsors are no longer required to suspend participant contributions to the plan after a hardship withdrawal. As a result, the firm’s data shows that only 3% of participants taking hardship withdrawals have actively lowered or stopped their deferrals by choice.
All in all, there seems to be an ongoing question as to whether the uptick in hardship withdrawals is tied directly to not having to take loans first, or whether disaster relief has had a bigger impact.
The firm emphasizes that one way to help decrease the likelihood that a participant would tap into his or her DC plan when experiencing a financial hardship is to help them understand the importance of having an emergency savings account. “Our research illustrates of the nearly 50% who had a financial emergency within the past two years and did not have an emergency savings account in place, 42% took a loan or withdrawal from their DC plan and 38% used a credit card to cover the expense,” the report observes.
Moreover, the firm notes that even though the BBA no longer requires plan loans be taken prior to requesting a hardship, plan sponsors may still consider requiring a loan before requesting a hardship. The firm also emphasizes enhanced educational efforts so that plan participants have a clear understanding of their options.
Eliza Badeau, Director of Workplace Thought Leadership with Fidelity, notes that it’s important to have a “withdrawal hierarchy – what’s the best route to go,” when considering a loan or hardship withdrawal. The paper acknowledges that for some participants, “taking a hardship may be their only option and may be a ‘lifesaver.’”
