COVID-19’s Effect on Retirement Savings Could Be Long-Lasting

More than one-quarter of respondents (26%) to the Edelman Financial Engines “2020 Financial Insights Study” have withdrawn money from their retirement or savings accounts during the COVID-19 pandemic.

Of those, more than one-third (39%) gave money to help a family member or friend in need, and more than half (51%) paid their own bills. On average, those who withdrew money say it will take almost six years to replenish their savings.

Separate research by Edelman Financial Engines shows actions detrimental to employees’ long-term financial security have increased 50% since April. Nearly half of those actions (45%) directly harmed retirement accounts (e.g., changing portfolio allocations, reducing savings rates and borrowing from the plan), while 30% increased outstanding debt and 21% reduced or depleted emergency savings.

The second survey of 1,902 U.S.-based retirement plan participants in August and September found a high prevalence of early retirement account access, with 28% reporting having previously accessed funds from their retirement plan. Of those, 43% have done so multiple times. COVID-19 is accelerating this trend, with 16% of participants currently considering early access and nearly half (46%) saying the primary reason is related to the pandemic.

Of those who withdrew or borrowed money from their retirement plans, 55% say they now regret it, according to the research. The regret may be well-founded.

The research report includes an illustration of the effects of a defined contribution (DC) plan loan. Edelman Financial Engines created hypothetical scenarios for a borrower named John who is 45 years old and has a $100,000 balance from which he can take a loan. John contributes 6% annually to his plan and his employer provides a 3% matching contribution. The scenarios assume a 5% loan interest rate, a 7% average annual investment return, that contributions to the plan are prohibited until the loan is repaid and a that a default could occur after two years, but the taxes and penalties incurred are removed from the default scenario.

In the best case scenario, John never borrows from his account and, by the time he is 70, his account is worth nearly $1.2 million. If he takes a $50,000 loan and repays it, his account is worth $992,519 when he’s 70. If he defaults on the loan, his account is only worth $590,247 by the time he’s 70.

To show the effect of a hardship withdrawal, Edelman Financial Engines performed a similar calculation for PLANSPONSOR. The calculation assumes a hardship withdrawal of $72,780, which, after paying taxes, yields $50,000 in after-tax funds, to be equivalent to taking out a $50,000 loan (22% federal tax, 9.3% California state tax). In this case, John’s balance at age 70 would be $774,833.

Edelman Financial Engines says this shows that taking a hardship withdrawal is even more detrimental to retirement savings than taking out a loan that is repaid.