ANN ARBOR – Divorce – not buying granite countertops for a renovation – is what causes people to withdraw from their retirement funds long before they retire, according to a University of Michigan researcher.
And the distress of mortgage payments is also a major factor, causing families to withdraw funds.
According to a working paper by economists Frank Stafford of UM and Thomas Bridges of the University of Delaware, Americans were most likely to access cash in their retirement accounts before retiring through divorce or after losing their job.
As of 2015, most Americans with retirement accounts have what economists call a “defined contribution” retirement account. That is, their accounts are self-funded retirement plans such as IRAs or 401 (k) s, compared to employer funded retirement plans, what economists call “benefit” accounts. defined ”. Defined contribution retirement accounts offer a lot more flexibility in when people can access their money, Stafford explains.
“These plans, now the dominant form of US pensions, also offer pre-retirement liquidity characteristics,” said Stafford, professor of economics and research professor at the Institute for Social Research at UM. “More and more, retirement savings are used to finance current consumption, especially in times of declining income. In addition, most employers allow members to interrupt their contributions to achieve greater current cash flow.
Specifically, people who need extra cash can withdraw money from their retirement accounts, or they can restrict the amount they contribute each month, thus slackening their cash flow.
Researchers have found that divorced households are 9.5% more likely to access “quick cash” by cashing in their retirement savings. They are also 11.8% less likely to continue contributing to a retirement savings plan. Losing a job increases the probability of cashing out by 3.5%, while a 10% increase in direct medical expenses increases the probability by 0.6%. That number could change with people losing their jobs – and health insurance – during the 2020 coronavirus outbreak.
“Based on our work, we expect to see significant access to pre-retirement pension balances and to cease participating in pension contributions in response to the economic impacts of the coronavirus,” Stafford said. “We also expect lower income, housing payment problems, family dissolution and divorce.”
The researchers’ assessment was based on the link between retirement savings and current income and consumption in light of the transition from defined benefit pensions to defined contribution pensions, which continued between 2001 and 2015, Stafford said. “This change has resulted in a greater proportion of households with access to liquid retirement savings, as well as a greater proportion of households whose retirement security depends on voluntary contributions.
To determine whether and under what conditions employees accessed funds from their retirement accounts, the study used data from the Panel Study of Income Dynamics. The PSID is a survey which has followed the same families and their descendants since 1968. In 1999, the PSID set up a module measuring the participation of households in retirement.
Stafford and Bridges sampled the nine survey waves that include wealth and pension data from 1999 to 2015. Within this subset, the authors further restricted their sample to married households aged 25 to 64, although that participants did not need to stay married throughout.
Households headed by 62 to 64 years of age were the most likely to cash out from their retirement accounts, followed by those aged 59 to 61 and 44 to 58.
The good news: Researchers haven’t found that homeowners are cashing in their pensions or reducing their contributions to renovate their homes or make other major purchases. This suggests that families are less willing to use their retirement savings as a “handy vending machine” for discretionary sustainable purchases, the researchers said.
In fact, the study found that large household purchases meant people were more likely to contribute to a household retirement savings account. People who received windfall benefits such as inheritances over $ 10,000 were also 4% more likely to continue contributing.
While the flexibility of direct contribution retirement accounts can help those in financial difficulty, borrowing from your retirement account now could have financial ramifications down the line.
“There is the short-term benefit of greater liquidity by reducing contributions or withdrawing money from retirement resources, and this liquidity feature can greatly benefit constrained households,” Stafford said. “However, the effect of repeated use of these more flexible retirement savings functions on the adequacy of long-term savings is of concern. It deserves further study.