Your Money Mindset

People who tapped 401(k) plan during pandemic are stealing from their future selves, advisors warn

Key Points
  • Hundreds of thousands of Americans have pulled money from 401(k) plans during the coronavirus pandemic. 
  • The CARES Act allowed savers to withdraw up to $100,000 before the end of the year without penalty. 
  • Thinking of retirement savings like a monthly income stream, similar to a pension or Social Security, instead of a lump sum of money may push savers to reconsider taking a distribution.
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Thousands of 401(k) plan savers have pulled money from their nest egg during the coronavirus pandemic.

This amounts to stealing from their future selves, some financial planners say.

Drawing down retirement savings early leaves less for one's golden years, and leaves less runway for future investment growth.

Some of this behavior was likely necessary for many people to fund basic living costs, given the extreme economic hardship and historic job loss caused by Covid-19. Many Americans had already been living paycheck to paycheck before the pandemic.

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But one behavioral trick — thinking of one's 401(k) more like a pension or Social Security — could have helped temper the whims of the more trigger-happy savers, according to experts.

"It could conceivably sober someone up who's thinking about withdrawing more than they need to get by," said Mark Iwry, a nonresident senior fellow at the Brookings Institution and a former senior advisor to the Treasury secretary during the Obama administration.

The CARES Act, a coronavirus relief law enacted in March, made it easier to pull money from one's 401(k).

The law allowed savers to pull out up to $100,000 in coronavirus-related distributions, penalty-free, through the end of 2020. Income tax could be spread over three years to minimize the tax hit.

Many took advantage.

Roughly 711,000 people saving with Fidelity Investments took such a distribution between April 1 and June 30 — representing about 3% of the company's eligible 401(k) and 403(b) plan participants. More than 18,000 asked for the full $100,000.

It's a dose of reality.
Mark Iwry
nonresident senior fellow at the Brookings Institution

More than 78,000 individuals with 401(k) savings at Vanguard Group took a coronavirus distribution as of May 31. On average, savers withdrew 60% of their 401(k) account.

The typical Vanguard client pulled out $10,413, was 43 years old and made $62,000 a year, according to the company. Assuming 4% net investment growth, this person could have turned that distribution into $25,000 by retirement age, Vanguard found.

Behavioral trick

This is where the behavioral trick comes in.

Income from Social Security and pension plans is paid in regular, monthly installments. But 401(k) savers are more apt to think of their nest egg in aggregate.

This may be unsurprising, given 401(k) account statements have historically focused more on the lump sum someone has saved rather than the income they can hope to generate from that savings.

This does a disservice to retirement savers, who are used to thinking in short-term installments, like with paychecks and bills, for example, experts said.

Thinking in lump sum terms can distort one's view of how far their wealth extends — and may lead savers to think they can afford to withdraw money, to their detriment, experts said.

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Take an old-school approach to retirement planning: the 4% rule.

Using this rule, a saver with $1 million could withdraw just $40,000 (4% of their account) in their first year of retirement, adjusting that value for inflation each year, to have a high probability of not outliving their savings over a 30-year-long retirement.

That amounts to about $3,300 a month before taxes — a sum perhaps more modest than anticipated. (This would, of course, be supplemented by Social Security in many cases and any other savings investors have handy.)

"At some point, they need to ask the question, what does this [lump sum] mean? How do I look at this in a way that's relevant to me retiring one day?" said Fred Reish, an attorney at the law firm Drinker Biddle & Reath and a retirement expert.

'Dose of reality'

Lawmakers are trying to shift Americans' thinking.

Last year, Congress passed a law, the SECURE Act, requiring 401(k) statements to provide an estimate of what one's account balance translates to in terms of monthly income.

Earlier this month, the U.S. Labor Department issued more specific rules around this provision.

Some 401(k) plans and companies already provide such information to savers. Investors in plans that don't will likely start seeing these projections in 2022, Reish said.  

"It's a dose of reality," Iwry said.