How emergency savings can help workers avoid 401(k) hardship withdrawals

More 401(k) participants are withdrawing from their retirement plans due to financial hardship, a recent Bank of America report found. In Q2, the number of participants taking hardship distributions increased by 36% year over year, according to a survey of employee benefits programs with more than 4 million participants conducted by the bank.

There are often penalties associated with hardship withdrawals, and participants incur additional income tax when they make the decision to withdraw. Employers can play a role in helping their workforce avoid early retirement withdrawals by keeping an open line of communication with investment partners, as well as expanding their suite of financial wellness benefits, experts told HR Brew.

HR 🤝 financial advisors. Hardship withdrawals tend to happen when employees aren’t engaged in their own financial planning, said Joe Allaria, a partner and advisor with CarsonAllaria Wealth Management. An employee might open up a 401(k) account even though they have $20,000 in credit card debt, for example.

To ensure that employees are better engaged with their retirement plans, he advised HR departments to keep an open line of communication with the investment firms they partner with so workers understand the resources that are available to them. “There’s no excuse… for an employer or employees to not know who the advisor is on their retirement plan,” Allaria said.

Look into emergency savings options. The root cause of a lot of hardship withdrawals is a lack of emergency savings, according to Nick Maynard, SVP at Commonwealth, a nonprofit focused on building financial security. Commonwealth has partnered with BlackRock on an Emergency Savings Initiative since 2019.

In recent years, “there’s been recognition that, near and around the retirement plan, having more options that employers can make available to protect that plan from folks immediately turning to hardships, as a path to handle emergencies, is valuable,” Maynard said.

This shift can be seen in the Secure 2.0 Act, a law with many provisions set to take effect next year. The law will allow “non-highly compensated employees” to link their retirement plans to an emergency savings account, and contribute up to $2,500 to that account each year. Employers may also allow 401(k) participants to withdraw up to $1,000 in emergency savings from their retirement plans per year without paying a penalty.

Maynard encouraged employers to keep an open line of communication with their retirement record-keepers and think about adding these options to their plans when they’re available.

He also recommended employers explore whether a non-retirement emergency savings fund would be valuable to their workers, in addition to other financial wellness benefits.

“HR teams and benefits teams have regular ways of talking to their employees and finding those things out,” he said. “And it can turn out that there might be differing needs for different types of employees.”

Some workers, for example, might want a portion of their paycheck to go to an emergency savings fund on a regular basis, and an HR department might explore this option through a partnership with a payroll platform. HR pros may consider partnerships with banks and credit unions, as well—BestBuy, for example, partners with Wings Credit Union on an incentivized emergency savings plan for employees.

Ultimately, the hope is that such benefits may help shore up employees’ retirement benefits, Maynard said. If employees have a dedicated emergency savings plan, they may feel more comfortable contributing to a 401(k) in the future.