More 401(k) plan participants are using their own plans as a source of income-either by requesting a hardship withdrawal, taking a loan, or just lowering or eliminating their contributions, according to a new study by Anne Lester, managing director and senior portfolio manager of JPMorgan Funds.

Lester says her study confirms that the current credit crisis and economic downturn are exacerbating erratic savings patterns, thereby increasing the risk of negative outcomes for retirement plans.

Nearly 20% of companies across the country have reported increases in loans and hardship withdrawals from their 401(k) accounts in the past quarter; 43% of these companies noted these loans and withdrawals were used to make mortgage payments, she notes. Other reasons cited included the need to cover personal bankruptcy, supplement normal spending or cover a family emergency.

The correlation between market volatility and erratic savings behavior is most compelling in areas with high foreclosure rates, she adds. As home sales plummeted in 2006 and particularly during the last half of 2007, these locations-particularly the South Atlantic, Midwest, and Southwest-not only experienced double the number of foreclosures since 2006, but 50% to 60% of plans in these areas also saw an increase in loans and withdrawals. As foreclosure rates rose to more than 2.5% in the state of Georgia, for example, one plan observed a 15% increase in loans. That same plan reported that 29% of participants had outstanding loans in the second half of 2007.

But the impact of loans and withdrawals on retirement plans was not limited to just those areas with high foreclosure rates. "During the height of the housing boom, all plans in our sample reported a 15% decline in outstanding loans. But when real estate values plummeted and the mortgage crisis began in 2007, these plans reported a 6% increase in the number of participants taking loans and a 6% increase in hardship withdrawals, with 74% of plans reporting an increase in the number of loans and/or withdrawals," she says.

The impact of participants' loans and withdrawals during this period of market volatility is expected to become even more significant over time, she says. "For example, participants now borrowing from plans during the current market downturn are selling assets at depressed values to fund the withdrawals. As a result, when the markets begin to rally at some point, participants are likely to be partially out of the market during the most crucial years for building capital, and will be forced to save more than they removed to get back to where they started in the first place," she says.

Lester offers several steps to help clients address negative behavioral patterns affected by the current market volatility. For the short term, she suggests selecting highly diversified target-date funds that are well positioned to overcome negative behavioral influences and deliver downside protection. For the long term, she says, advisors need to educate and communicate with clients on an ongoing basis.