Mastering Difficult Conversations: Employee 401k Withdrawals
When stuck in a sticky financial situation, an employee may need to rely on their retirement savings to help them get by. Depending on the rules of your company’s plan, the employee can either take a hardship withdrawal or loan. It is important to understand the difference between the two and when each should be used; because ultimately neither should be used unless completely necessary.
A hardship withdrawal is taken from the 401k account in times of “immediate and heavy financial need,” and only enough money to satisfy this need plus income taxes can be withdrawn. The withdrawal does not need to be paid back, but it will be taxed by local, state, and federal government. It is also subject to a 10% withdrawal penalty if the participant is under 59.5 years of age. Another consequence is that there is a six month period post withdrawal in which the employee is suspended from contributing to the account. In order to take a withdrawal, there are often strict guidelines of the situations in which it is acceptable, as well as specific types of proof which must be documented.
On the other hand, a loan (which in most cases must be taken before relying on the withdrawal) is much easier to obtain as it can be taken “for almost any reason.” However, these must be paid back over five years with interest. Moreover, there is no credit check on this type of loan and the employee may still contribute to their account during this period.
In both cases, there are consequences that result from delving into ones retirement funds prematurely, and the best solution is to prevent it unless completely necessary. The best way to do this is to educate employees. This can be done by having employees speak to a financial advisor before making a decision, because many employees don’t recognize all of the consequences that ensue. It is also beneficial for an employer to provide employees with workshops, webcasts and online tools to help them understand the options they have in a financial crisis.
Most importantly, if possible it is often in the best interest of the employee to avoid a hardship withdrawal or loan. To deter an employee from doing so, use these five tips to help you:
Plan ahead: Set a payoff timeline with the participant. Encourage them to pay off the loan earlier than five years, and price out the ‘per paycheck effect’, dollar amount deduction after taking the loan out. Write this on a piece of paper, and have the employee sign it.
Inform: Show the employee the effect of the withdrawal (you can use the calculator by going here: https://www.calcxml.com/calculators/qua11).
Inquire: Ask them the reason for requesting the loan.
Caution: Let them know about termination risk (60-90 days to pay off loan in full if terminated from employment). Loans not repaid are taxed as ordinary income and, if taken prior to age 59 ½, may be subject to an additional 10% withdrawal penalty and possibly state income taxes.
Explain: Describe the double-tax effect to them: The money you withdraw as a loan doesn't get taxed and loan repayments are made with after-tax dollars. Distributions are taxed a second time when paid out for retirement.
Helping your employees deal with financial hardship is never an enjoyable situation to be in, but it is a role you must master. The ability to tactfully navigate this difficult conversation with an employee could ultimately gain you a higher sense of trust, loyalty, and respect from your employees.