The current, and longest-ever, federal government shutdown has made it painfully clear that many of Uncle Sam's employees don't have an emergency savings cushion.
They are not alone.
A study released last summer found that only about a quarter of all Americans across nearly all ages and generations have no savings whatsoever in an emergency fund. Just more than a quarter of U.S. residents, 29 percent, had saved enough to cover six months' worth of living expenses.
When people do save, they tend to do so for retirement.
It's not necessarily that they're looking ahead to their golden years. Rather, it's because many workplaces offer defined contribution plans, typically 401(k)s, that make it easy for folks to automatically stash a bit of retirement money every pay day.
These plans help reduce workers' taxes by having the money go into the savings plan before taxes are calculated. The contributions, often including an amount also contributed by the boss, then grow tax-deferred until they are withdrawn once the account owner retires.
Workplace retirement plans being tapped: So it's no surprise that when folks face an emergency, they consider tapping their only substantial source of savings, their workplace retirement accounts.
That is happening now with federal employees who are going to their jobs but getting now pay or who are furloughed.
The federal employee equivalent of a private-company's 401(k) is the Thrift Savings Plan. Around 5.5 million federal workers were participating in this retirement vehicle as of Dec. 31.
Federal Retirement Thrift Investment Board data show a 34 percent jump in the number of hardship withdrawals in the two and a half weeks after Christmas (the shutdown began Dec. 22, 2018) when compared to the same period last year. The data goes through Jan. 14, the first weekday after many federal employees missed their first paychecks of the new year.
I'm not here to debate whether taking out retirement money is a good or bad move. Savings, like taxes, are intensely personal and every person's unique financial and family situations dictates what moves should or shouldn't be made.
But retirement plans, both for federal workers and private sector employees, do allow hardship withdrawals. And they also involve, of course, taxes.
Here are five things you need to know if you're considering taking a hardship withdrawal from your workplace retirement plan.
1. Hardships withdrawals aren't automatic. While these special-circumstance withdrawals are allowed, your employer doesn't have to offer them. So before counting on using your retirement money to cover some unexpected and unexpectedly large expenses, check with your plan administrator.
2. Hardship withdrawals have been expanded. The Bipartisan Budget Act passed in January 2018 included rule changes that make it easier for workers to withdraw a larger amount as a hardship withdrawal. Before the Budget Act changes, you could only withdraw your own salary-deferral contributions, that is, the amounts you had withheld from your paycheck. But under the new rules, which took effect this year, in addition to the money you put into the plan you now also can withdraw your employer's contributions (most match up to at least 3 percent of worker contributions), plus any investment earnings.
3. Not everything qualifies as an allowable hardship. Obviously, you can't simply take out retirement plan money because you want something. Enough people, however, have tried that withdrawal approach so that the IRS felt compelled to specifically state on its website that:
"Consumer purchases (such as a boat or television) are generally not considered an immediate and heavy financial need."
Rather, the IRS notes that workplace retirement plan hardship withdrawals are only allowed when there's an immediate and heavy financial need. You are automatically considered to have an immediate and heavy financial need if you need your retirement plan money for any of these situations:
- Medical care expenses for yourself, your spouse, any dependents or plan beneficiary;
- Costs directly related to the purchase of your principal residence (excluding mortgage payments);
- Tuition, related educational fees and room and board expenses for the next 12 months of post-secondary education for yourself or spouse, children, dependents or beneficiary;
- Payments necessary to prevent your eviction from your principal residence or foreclosure on the mortgage on that residence;
- Funeral expenses for yourself, spouse, children, dependents or beneficiary; and
- Certain expenses to repair damage to your principal residence.
Hardship withdrawals also are often made available to folks who've sustained major natural disaster damages.
To verify that you meet the hardship withdrawal rules, your employer will ask for certain information and documentation.
4. There are limits on how much can be withdrawn. While the new rules expand the amount that can be taken as a hardship withdrawal from a retirement account, there still are limits.
The IRS says these withdrawals are limited to the amount needed to cover the immediate and heavy financial need.
Plus, you also must show that you cannot reasonably obtain the needed funds from any other source. This means you can't get the cash from such things as insurance or other types of reimbursement, liquidation of your assets or loans.
5. Be aware of the tax costs. If you are younger than age 59½, then any withdrawal from a tax-deferred workplace retirement plan is subject to the applicable ordinary income tax.
The withdrawal for younger account owners also may be subject to a 10 percent early distribution penalty.
Hard choices for hardship situations: The literal bottom line is that taking money out of your workplace retirement plan will cost you in the long run. Your nest egg will be smaller, meaning you'll have to work longer or revise the type of retirement lifestyle you want.
But if you're facing immediate eviction or foreclosure, a hardship withdrawal from a 401(k) or similar workplace retirement plan could be the best or only way to keep you and your family in your home.
You also might find these items of interest:
- Retirement plan inflation adjustments for 2019
- Government shutdown could revive tax refund advance products
- Tapping retirement accounts early is a dangerous trend among young savers