Laid-off workers tapping 401(k) funds to survive
With no paycheck, many cash out to cover mortgage, groceries
As the last of his severance pay dwindled away in March, Brad Cleghorn of northwest suburban Marengo cashed out his 401(k) plan in order to pay his mortgage and feed his family.
Cleghorn is not alone. A Hewitt Associates study shows that 46 percent of workers with 401(k) plans who lost or switched jobs cashed the plans in, a trend that could lead to serious problems when younger generations of people working today reach retirement.
(Rich Chapman/Sun-Times)
For a married couple filing jointly in the 25 percent tax bracket (income between $67,900 and $137,050), a $10,000 withdrawal would incur a $1,000 penalty plus $2,500 in income tax, leaving only $6,500.
Some cashouts are exempt from the 10 percent penalty, including money paid to those 55 or older at the time they lose their jobs, money to pay medical expenses that are more than 7.5 percent of income, or money to pay divorce settlements.
'"They don't have anything else to fall back on," said Pamela Hess, director of retirement research for the human resources consultant. With Social Security uncertain and providing only a minimum safety net, "the 401(k), that is their main retirement vehicle."
Hess noted that a 25-year-old cashing out $5,000 today may be sacrificing $75,000 at retirement (assuming a 7 percent return until age 65).
"If people continue to cash out what seems like a small bit of money, over time it's certainly going to sabotage their retirement."
"What retirement?" asks Cleghorn, 41. "I don't think people my age are even thinking about retirement. I expect having to work somewhere for the rest of my life. Gone are the days where you can work the same job for a couple of decades or more and retire with a pension."
An information technology professional who has worked in project management and network administration, Cleghorn was laid off in January when his company was sold to a foreign firm and shut down.
He got seven weeks of severance pay, and when that ran out, he had no choice but to tap his 401(k).
"Necessity outweighs any other thing, any investments. You have to pay your bills, and paying your bills means more than any other kind of return your investments are going to give you," Cleghorn said.
"So we made a decision it was necessary for us to keep the lights on, to keep food on the table for the kids. We have to do what we have to do, and whatever penalties we face on next year's tax return, we'll worry about that next year."
Lou Watson, who maintained computer databases for a Chicago electronics distributor and was laid off in March, was up against the same wall.
His first unemployment check was overdue, and "I had to pay rent, utilities and all that stuff, so there was really no other option," he said. "I didn't want to, but what can you do?"
The "few thousand" Watson got has helped tide him over while searching for work.
"I'm the type of person who doesn't like to keep calling home and asking my mom for money."
The Hewitt study of 170,000 401(k) participants who lost or changed jobs in 2008 showed that those with larger sums in their plans tended not to cash out as much. Also, younger workers were more likely to cash out than older workers.
Six out of 10 employees in their 20s took the money, compared with one-third of those in their 50s, according to the study.
But Evanston resident Michael Cook, 57, has been laid off twice and cashed out 401(k)s twice in the last four years.
The first time, he got about $6,800; the second, about $1,600.
A medical billing supervisor who is still looking for work, Cooke sometimes wishes he had rolled over at least part of the money. But, "Bottom line, I have no regrets. It was necessary to pay for my living expenses, my car and what have you."
Though Hess agrees that hardship can justify cashing out, she points out that many who are simply switching jobs use that opportunity to take the money and run.
"Just because you change jobs, that shouldn't be a reason for you to take it out," said Hess.
So the Hewitt study recommends that regulators make it more difficult for people to cash out 401(k) plans, perhaps by limiting access until age 59½, with exceptions for hardship cases.
Hewitt is also proposing making the rollover process simpler and that companies offer 401(k) participants lower-fee institutional funds, which according to the study retained more money than some higher-cost mutual funds.
Cleghorn, however, says the changing job market and the up-and-down economy are making the concept of a 401(k) as a retirement option almost irrelevant.
When he lost an earlier job in the tech bubble burst of 2001, he also tapped his 401(k).
"It's nice to think, 'That's my retirement,' " he said. "But it's also my safety net because you just never know when the economy will turn south and you need to have that safety net."