More people are making hardship withdrawals from their 401(k) accounts, raiding retirement funds to cover emergency medical expenses, or to avoid losing a home.
Hardship withdrawals from Fidelity Investments 401(k) accounts have tripled in five years, according to a report from the investment firm. The share of plan participants withdrawing funds rose from 2.1% in 2018 to 6.9% in 2023.
“It’s a big problem, and it’s a growing problem,” said Kirsten Hunter Peterson, vice president of thought leadership at Fidelity.
Vanguard reports that hardship withdrawals have doubled in a four-year span, from a monthly rate of 2.1 transactions per 1,000 participants in 2018 to 4.3 in 2022.
Americans who tap retirement funds to cover an urgent expense often act out of desperation, investment experts say. They may lack emergency savings and live on too tight a budget to risk taking out a loan.
“What we know is that people will dip into their 401(k) when they don’t have any other savings tool available to them,” Peterson said.
Yet, taking a hardship distribution from a traditional 401(k) plan is far from ideal, financial planners say.
Hardship withdrawals from a 401(k) should be a ‘last resort,’ experts say
The IRS treats the money as taxable income. You may also face an additional 10% tax penalty for making an early withdrawal from your retirement account. (The IRS publishes a handy list of exceptions to that penalty.) You aren’t allowed to repay the funds, and you will miss out on the compounded interest those dollars might have earned between now and your retirement.
The costs can be steep. Let’s say you have a 401(k) with a $38,000 balance, and you need $15,000 for an unexpected expense. To cover all the taxes, including the 10% penalty, you would have to withdraw a total of $23,810, leaving only $14,190 in your depleted account, according to an example provided by Fidelity.
“We see it as a last resort,” said Andrew Fincher, a certified financial planner in Vienna, Virginia. “It’s not a great place to go.”
The rise in hardship withdrawals comes at a moment when, compared to four or five years ago, many Americans are spending more and saving less.
Workers are saving 3.9% of their disposable income, as of August, compared with 6.6% in August 2018, according to federal data.
Saving money is hard these days, because inflation is up. Annual inflation hit a 40-year high of 9.1% in June 2022. The annual rate eased to 3.7% in September, although that figure remains higher than the Fed’s target of 2%. Through much of the past decade, prices rose by 1% or 2% in a typical year.
