401(k) withdrawals spike

NEW YORK (CNNMoney.com) -- Hardship withdrawals from 401(k) retirement saving plans rose to the highest level in 10 years during the second quarter, Fidelity Investments said on Friday, in the latest sign of a dismal economy.

Fidelity reported that, as of the second quarter, 2.2% of all 401(k) participants had made a hardship withdrawal at some point over the preceding 12 months. That's up from 2% in the prior year, and was the highest level in 10 years.

At the same time, the percentage of 401(k) participants that had an outstanding loan from their account rose to a record high of 22% in the second quarter. The average loan amount was $8,650 at the end of the quarter.

Boston-based Fidelity has $844 billion in retirement assets under management.

The top reasons people took loans and made withdrawals were to prevent foreclosure or eviction, pay for college, or purchase a home, according to the firm.

"The current economy has forced some workers to borrow from their 401(k) accounts in order to pay for critical living expenses, ultimately jeopardizing their future retirement," said James MacDonald, president of workplace investing for Fidelity Investments.

He added that for some investors "taking a loan or a hardship withdrawal from their 401(k) may be their only option because it's their only form of savings. However, we want to make sure that before workers tap their retirement accounts prematurely, they are fully educated about both the penalty that may be incurred and the long-term implications for their retirement."

Fidelity said that withdrawals made by people younger than 59-and-a-half years old are taxed and are subject to a 10% penalty. The age of people making withdrawals ranged from 35 to 55.

David Wray, president of the Profit Sharing/401(k) Council of America, said that people making hardship withdrawals could pay a penalty of up to 40%, once state and federal taxes are added to the 10% penalty.

"People take a very significant hit when they take a hardship withdrawal," he said.

Wray said the increase in hardship withdrawals "is clearly directly tied to the economic situation and probably more specifically to the housing situation." But he also noted that nearly 98% of people with Fidelity 401(k) plans are not making withdrawals.

"It's important to keep in context that nearly all 401(k) participants are not taking hardship withdrawals," he said.

The penalties for hardship withdrawals are so high that participants should brace their finances ahead of tax time, said Beth McHugh, vice president of market insights for Fidelity.

"People should be prepared, because when it comes time to do their tax filing, that money is taxed as income," she said. "They need to make sure they keep some of that money aside so they can use it to pay their taxes instead of spending it."

Unlike withdrawals, loans are required to be paid back, with interest but without a penalty. Wray said the interest rate for most borrowers would be about 4.5%, to be paid back in five years.