PETOSKEY -- Defined-contribution retirement accounts, such as the well-known 401(k) programs offered through many employers, have become one of the most common tools for Americans to save for their later years.
But as recent national media reports have noted, not all of the billions of dollars channeled into those accounts end up paying for retirement needs -- and the trend is one which two Petoskey-based financial advisers see as concerning.
"I think it's a concern for (account holders') future retirement planning," said Shaun Osborne, a certified financial planner and managing partner in financial advisory firm OsborneKlein. "Primarily they're losing the ability of growth of those funds, which ultimately is eroding their income during their retirement years."
Online financial guidance company HelloWallet detailed the phenomenon in a 2012 paper, "The Retirement Breach in Defined Contribution Plans."
The paper noted that a majority of U.S. employers use 401(k) and other defined-contribution accounts to encourage workers to save for retirement, often providing matches for employees' contributions to the account. But more than 25 percent of households that use this type of retirement plan have withdrawn, or breached, their account balances for spending needs outside of retirement -- with annual withdrawals totaling more than $70 billion.
Plans in some workplaces offer loans as one non-retirement withdrawal option for workers, allowing them to borrow up to 50 percent of their vested account balance or $50,000, whichever amount is lower. When departing a given job, cash-outs allow workers to withdraw all or part of their savings from an account, although these typically involve tax consequences. Withdrawals often are available for situations such as financial hardships, age (59 1/2 or older) or, at some employers' discretion, non-hardship uses.
Osborne, whose firm has offices in Petoskey and four other Michigan communities and is affiliated with Ameriprise Financial Services, said clients typically are motivated by one of three reasons when they present him with questions about pre-retirement withdrawals from an account such as a 401(k).
One such reason is need. Osborne said there's often a pressing financial need that the client is looking to address by taking a loan from the account. But since 401(k) proceeds are protected in the event of bankruptcy, Osborne cautions that a withdrawal could create more jeopardy if one is approaching dire financial straits.
Want is another reason that 401(k) users may seek a withdrawal, Osborne said, perhaps a desire to use the funds to pay off debts. But when the retirement savings are pulled away from investments for these purposes, he said a concern arises about building income for later-life needs.
Clients also may be motivated by fear of financial market declines when they seek to move funds out of a 401(k) account, Osborne noted, but added that 401(k)s typically offer more stable investment choices if one wants lower risk than stock funds involve.
David Farley, a Petoskey-based financial adviser with Raymond James & Associates Inc., Member New York Stock Exchange/SIPC, sees two types of potential problems which pre-retirement withdrawals can sometimes present.
"Taxes and penalties are probably the foremost reason to avoid withdrawals in the short term," he said. "Withdrawals are taxed at your current tax rate and can push you up brackets. Additionally, penalties can be as high as 20 percent. If you throw state taxes on there, it is possible to get the tax rate with penalties near 50 percent. People often do not understand the math very well.
"Say a taxpayer has a 30 percent tax and penalty. They need $5,000 so they distribute $6,500, thinking 30 percent of $5,000 is $1,500, added to the $5,000. They are either going to get less money than they think, or have a bigger tax bill because the tax is based on the final number. So, if the total withdrawal was $6,500, the tax and penalty would be $1,950. In this case, the taxpayer would need to withdraw about $7,140 to get a net of $5,000 and not have taxes due next April 15.
Also, "Let's not forget the long-term problem with raiding retirement funds ... they will not be there when one may have hoped to retire," Farley said. "The challenge is not that one may choose to work later into life; it is if one does not have the capacity to work later in life, due to health issues."
Farley and Osborne see accounts such as the 401(k) as a useful tool for retirement savings.
With workers typically contributing through payroll deduction, "the money is never a part of your budget because you never see it," Farley said. "It is much less painless than receiving the money and then having the discipline to make a contribution.
Also, "there is often an employer match that is a great way to get an immediate return on your investment," he added. "For example, if your employer has a match up to 3 percent of compensation, you can put 3 percent in and effectively get a 100 percent return on your money. Generally there are strings attached that do not allow you access to the match immediately and/or penalizes you for withdrawals."
Osborne, too, sees the payroll-deduction and employer match aspects of a 401(k) making it a helpful mechanism for retirement savings.
"I think it is generally a primary place for people to save (for retirement)," he said. "At the same time, there are other options that people should consider concurrently."