Penalizing Precarity

Retirement policy in America is oriented around 401(k) plans and other employer- sponsored savings plans, which together will receive a whopping $1.5 trillion in tax subsidies over the next decade. This Article uncovers a harmful flaw in the policy governing withdrawals made prior to reaching retirement age: an unnoticed gap between the rules governing plan distributions and the rules imposing penalties on employees in certain situations. Employees are generally required to seek approval from their plan administrator to receive a “hardship distribution.” These requests are granted for employees who face an “immediate and heavy financial need,” such as eviction or an unexpected medical expense. However, even with this approval, these distributions are frequently subject to an “early withdrawal penalty” under a separate regime that is not coordinated with the hardship distribution rules. We document instances of employees who were able to survive financial calamity because of a hardship distribution only to learn that they now face a tax penalty—resulting in another cash crunch. Retirement plans disburse over $16 billion in hardship withdrawals each year, and the funds go to the most financially precarious households—ones that have fewer assets, lower incomes, and are more likely to be Black or Hispanic. Recognizing the existence of this gap also exposes a fundamental flaw in retirement savings policy: under the existing rules, some workers are made worse off by trying to make use of 401(k) plans. This Article introduces several reforms to protect against penalizing financial precarity by integrating hardship distributions with the early withdrawal penalty regime. We also explore broader reforms to effectively reduce financial precarity among lower-income and lower-asset households.