Credit Crisis Affecting 401(k) Plans

The Financial Advisor Magazine is reporting, "Credit Crisis is Affecting 401(k) Plans".

More 401(k) plan participants are using their own plans as a source of income—either by requesting a hardship withdrawal, taking a loan, or just lowering or eliminating their contributions, according to a new study by Anne Lester, managing director and senior portfolio manager of JPMorgan Funds.

There are some sobering thoughts presented here. The impact of loans and hardship withdrawals is taking on a special significance:

Nearly 20% of companies across the country have reported increases in loans and hardship withdrawals from their 401(k) accounts in the past quarter; 43% of these companies noted these loans and withdrawals were used to make mortgage payments, she notes. Other reasons cited included the need to cover personal bankruptcy, supplement normal spending or cover a family emergency. The correlation between market volatility and erratic savings behavior is most compelling in areas with high foreclosure rates, she adds.

As home sales plummeted in 2006 and particularly during the last half of 2007, these locations—particularly the South Atlantic, Midwest, and Southwest—not only experienced double the number of foreclosures since 2006, but 50% to 60% of plans in these areas also saw an increase in loans and withdrawals. As foreclosure rates rose to more than 2.5% in the state of Georgia, for example, one plan observed a 15% increase in loans. That same plan reported that 29% of participants had outstanding loans in the second half of 2007.

But the impact of loans and withdrawals on retirement plans was not limited to just those areas with high foreclosure rates. “During the height of the housing boom, all plans in our sample reported a 15% decline in outstanding loans. But when real estate values plummeted and the mortgage crisis began in 2007, these plans reported a 6% increase in the number of participants taking loans and a 6% increase in hardship withdrawals, with 74% of plans reporting an increase in the number of loans and/or withdrawals,” she says.

The perils of buying high and selling low are revisited:

The impact of participants’ loans and withdrawals during this period of market volatility is expected to become even more significant over time, she says. “For example, participants now borrowing from plans during the current market downturn are selling assets at depressed values to fund the withdrawals. As a result, when the markets begin to rally at some point, participants are likely to be partially out of the market during the most crucial years for building capital, and will be forced to save more than they removed to get back to where they started in the first place,” she says.

Some pointers for advisors on how to deal with clients:

Lester offers several steps to help clients address negative behavioral patterns affected by the current market volatility. For the short term, she suggests selecting highly diversified target-date funds that are well positioned to overcome negative behavioral influences and deliver downside protection. For the long term, she says, advisors need to educate and communicate with clients on an ongoing basis.

[Emphasis added]

WSJ Report: Investors Pull Money Out of Their 401(k)s

Jennifer Levitz of the Wall Street Journal [subscription required] writes in the journal dated 9/23/08, "Investors Pull Money Out of Their 401(k)s - Hardship Withdrawals Rose In Recent Months, Plans Say; Concerns About Tax Penalty."

With stocks falling, credit tightening and unemployment rising, small investors have been raiding their 401(k) accounts or slashing contributions to the popular retirement plans, according to the latest tallies of plan administrators. Others, eager to shield their portfolios from further damage, are reducing their exposure to stock mutual funds to near record lows.

...

The behavior -- described by some market watchers as panicky in the past week -- has led to worries that the retirement prospects are dimming further for Americans, most of whom no longer have private-sector pensions to rely on.

Recent 401(k) winnowing is coming in the form of "hardship withdrawals" -- removing cash from the fund, with a 10% tax penalty, for exigencies such as job loss, the prospect of losing your home to foreclosure or a big medical expense.

T. Rowe Price Group Inc. in Baltimore saw a 14% increase in hardship withdrawals in the first eight months of this year, compared with the same time last year. Boston-based Fidelity Investments says the number of workers with hardship withdrawals rose 7% from April through June, compared with the same time period a year earlier. Principal Financial Group Inc., in Des Moines, Iowa, says that requests for hardship withdrawals are up 5% this year through Sept. 18, over last year, and that the withdrawal amounts are larger.

...

Jim Wharton, a 65-year-old retired Sears Holding Corp. manager in Queen Creek, Ariz., says he moved his entire 401(k) balance of $357,000 to certificates of deposits insured by the Federal Deposit Insurance Corp. recently. The money had been invested in a "stable-value" fund, typically a low-risk, low-yield fund that invests in bonds and interest-bearing contracts backed by insurance companies. He says his next move may be "under the mattress."

According to Hewitt Associates Inc., a Lincolnshire, Ill., consulting firm, the total stock allocation among 401(k) participants is at a five-year low, declining to 62% in August from 68% a year earlier. Hewitt attributes the decline to an unusually high number of investors transferring money into fixed-income funds. It said it believes the trend continued into September.

...

Ms. Schlesinger, the Providence investment adviser, says many workers who were too heavy on stock mutual funds going into the crisis have taken hits on their balance and now wonder what to do.

If they are young, she advises them to rotate slowly into more conservative investments -- to avoid selling their investments at a low price.

But, she says, if they are five years or less from retirement she is advising them to immediately protect their portfolio from further decline by moving at least 30% or 40% into fixed-income accounts. For many investors, that will mean "taking a loss," she says. She says, "I tell them, 'I'd like to think that the rescue plan is at the bottom of the market, but what if it's isn't? We can't gamble with that.'"

Effects of the Recession on 401(k) Participation

News of gloom and doom in the economy is all around us - so I will not bore you with them. Let us turn our focus instead on what I think are two important shifts in participant sentiment that may be taking place out there:

• Participants are more willing to use their 401(k) accounts as rainy day funds
• Participants in some important pre-retirement and near-retirement demographics are making subtle but significant changes to their participation levels (rates).

BankRate.com is reporting (via Yahoo! Finance): 401(k) hardship withdrawals on the rise (some quotes from Vanguard's Center from Retirement Research, and Hewitt, followed by some pithy remarks on common sense cash management exercises for the entire family):

Cash-strapped employees are turning to their retirement plans as the credit crunch drags on and costs for everyday necessities continue their upward spiral. While hardship withdrawals from 401(k) plans are taken by a very small number of participants -- about 1.5 percent at Vanguard -- the giant fund company says hardship withdrawals have been increasing significantly; up about 17 percent in 2006 and another 9 percent in 2007.

...

Hewitt Associates tracks 1.5 million 401(k) participants at large corporations and says the trend for hardship withdrawals is continuing in 2008, and they don't expect to see that trend change throughout the rest of the year.

The number of loans from 401(k)s are holding pretty steady around 22 percent of participants at any given time, according to Pam Hess, director of retirement research at Hewitt.

Along the same lines, but focusing more on participation levels as opposed to hardship withdrawal issues, the WSJ is reporting today: Unsteady Economy Prompts 401(k) Strategy Shifts. Important takeaways:

• Boomers (55-64 year olds) appear to be saving more to compensate for subpar investment performance
• Yet, according to AARP, 33% have "stopped putting money in a 401(k), IRA or other retirement account." (Presumably this applies to AARP's core audience, but the article does not clarify)
• According to Charles Schwab Corp., "7.1% of active employees reduced their 401(k) savings compared with a 5.2% in the last quarter of 2007 and a 5.8% in the first quarter of 2007."
• "You have higher gas prices, higher food prices, higher college and healthcare costs," says Dean D. Kohmann, vice president sponsor services, corporate and retirement services at Charles Schwab.
  Kohmann says one silver lining is that the current economy is persuading more consumers to get financial advice, which is good long term.
  "The more people have a plan, the less likely they are to reduce [contributions,]" he says. "If you can keep contributing now, you'll have more shares at a lower price."
• Woohoo - more financial planning!
• A bit of good news from Wells Fargo: "Wells Fargo has since January seen customers go in both directions. It found that 30% of consumers who made a change to their contribution rate between January and mid-June decreased their savings -- 15% dropped it to zero.
  However, 70% of those who made a change increased their contribution, says Laurie Nordquist, executive vice president of Institutional Trust Services for Wells Fargo."