In this time of high unemployment, people are tapping into their retirement savings at a record rate to make ends meet, a trend that finance experts say could jeopardize their futures.
Boston-based Fidelity Investments reports that in the 12 months ending in July, its customers made a record number of withdrawals from 401(k) plans for hardship, with the majority trying to prevent eviction or foreclosure.
Only 2.2 percent of the 7.5 million employed Fidelity customers with 401(k) accounts made hardship withdrawals in that period, which was up from 2 percent a year earlier and 1.4 percent in June 2006.
A measure of these workers' financial desperation: Of those who took a hardship withdrawal in the year ending in June 2009, 45 percent dipped into their retirement fund again in the next 12 months.
"People are being faced with repeat hardships," said Beth McHugh, a Fidelity vice president.
Also, she said, most people who take a hardship distribution have already taken a loan against their 401(k). She said most 401(k) plans would not allow a hardship distribution until loan alternatives were exhausted.
Hardship withdrawals can be taken only for specific reasons. In addition to preventing foreclosure, they include medical expenses, college tuition, the purchase of a home to live in and funeral expenses.
Loans against a 401(k) can be for anything and borrowing can be half of the vested balance or up to $50,000.
Fidelity found that 11 percent of workers who had 401(k) accounts took out loans in the 12 months ending in June, up from 9 percent a year earlier. More than one in four 401(k) holders had a loan outstanding.
Another 401(k) activity study by Hewitt Associates similarly found that withdrawals reached a historic high last year and continue to climb this year.
Clients "are using the money for near-term needs and so they will have less money to pay for retirement. People are going to have to work longer and longer," said Pam Hess, Hewitt's director of retirement research.
Another setback for retirement savings comes when a person who loses a job chooses to cash money out of a 401(k) rather than roll it into an IRA or to keep it with a former employer while looking for other work.
Vanguard, another retirement fund management company, said last year it noticed a small increase in the percentage of clients in this situation who took cash from their retirement accounts and presumably spent it.
"Given the ongoing uncertainties in the employment market, we anticipate an increase in cash-outs in the near term, under the assumption that plan savings are sometimes used as a personal form of unemployment insurance," Vanguard said in an annual report.
Experts acknowledge that sometimes tapping a 401(k) can be the only option for a family when a breadwinner loses a job.
"If it comes down to buying groceries... what would most people do?" said Stan Hargrave, an investment adviser in Riverside, Calif.
Hargrave said studies also show that people who have saved $5,000 or less in their retirement accounts tend to cash out instead of rolling the money into another retirement plan. He said one excuse they give is the stock market's poor track record in the last decade.
"The majority of people have no idea how to manage their money for retirement," he said.
"We are seeing that for some individuals, their 401(k) is their only way of saving," said Fidelity's McHugh.
Unlike a traditional savings account, 401(k)s are designed to discourage withdrawals or borrowing.
An advantage of a 401(k) is that taxation is deferred on the money contributed into the fund while it grows through investment. But money borrowed from a 401(k) must be repaid, with interest, in after tax dollars that will be taxed a second time when the money is withdrawn. Also, a loan must be repaid in full if the borrower becomes unemployed to avoid having it considered a distribution.
Workers who take a hardship distribution from their 401(k) must pay income tax on it. Those younger than 59 and a half also must pay a 10 percent penalty.
Hewitt's Hess said there might be advantages to taking a 401(k) loan, such as borrowing at a relatively low interest rate to pay off a credit card with a high interest rate. "It is not harmful if you are able to pay it back in full and keep saving for retirement," Hess said. But some people postpone making regular 401(k) contributions while repaying the loan.
Withdrawals are more damaging than loans, she said, because "you are permanently removing money from the system and paying taxes and penalties." Moreover, she said, if you withdraw money from a retirement account once, you're more likely to do it again.