Grant’s Go-To’s: What Should We Make of Early Withdrawal Options in SFRP’s?
“only 23 percent of people with annual incomes of $20,000 or less, and only one-third of people with annual incomes of $20,000 to $30,000 said they would be able to come up with $2,000 in 30 days if an emergency arose.”
Withdrawing funds from a retirement account prior to retirement is generally frowned upon, and with good reason. Withdrawals are a form of “leakage” that not only limit the long-term growth of account funds, but also come with potential tax penalties.
While the perils of early withdrawals are real, it may make sense to keep an open mind when it comes to state-facilitated retirement programs (SFRPs). SFRPs are aimed at lower-income workers, many of whom lack sufficient savings to pay for financial emergencies.
A 2009 University of Wisconsin study found that only 23 percent of people with annual incomes of $20,000 or less, and only one-third of people with annual incomes of $20,000 to $30,000 said they would be able to come up with $2,000 in 30 days if an emergency arose. The authors also cite evidence indicating that even modest savings can help families exit from poverty.
Perhaps SFRPs have some role to play in not only helping workers save for a secure retirement, but also to build savings that can help with unexpected emergencies. Providing some flexibility to access savings early might provide potential savers with comfort and make them less likely to opt out.
The CalSavers website provides the following assurance: “While the program is meant to help you save for retirement, we understand that life has its ups and downs. What you do with your savings is entirely up to you, and the money you save is available to you if you need it in an emergency.”
CalSavers, Illinois Secure Choice, and OregonSaves offer Roth IRA accounts. With Roth IRAs, there’s a 10 percent tax penalty for early distributions of investment earnings prior to age 59 ½, but original contributions can be withdrawn tax-free because taxes were already paid on the money invested.
This makes Roth IRA’s a fairly flexible savings tool.
In contrast to Roth IRAs, early withdrawals from traditional IRAs and 401(k)s are subject to the tax penalty except for narrow exemptions for withdrawals related to permanent disability, loss of employment and medical expenses.
For next time, I plan to look at what impact pandemic unemployment might have played on retirement account withdrawals as a whole, and with the California, Illinois and Oregon SFRPs in particular.
Stay tuned! - Grant
This piece was featured in the April 22, 2021 edition of Retirement Security Matters. For more fresh thinking on retirement savings innovation, check out the newsletter here.
