The Real Impact of 401(k) Hardship Withdrawals - 401k Maneuver

The Real Impact of 401(k) Hardship Withdrawals

While data shows more people are saving for the future, others are putting their financial futures at risk by taking 401(k) hardship withdrawals.

401(k) hardship withdrawals should be a last resort, but people are playing fast and loose with their retirement savings, as shown by recent reports from Vanguard, Bank of America, and Fidelity.

According to Bank of America: 

  • Roughly 15,950 participants took hardship distributions in the second quarter of 2023, up 36% from 2022
  • The average participant hardship amount is $5,050

Vanguard’s How America Saves 2023 Report claims, “In 2021, overall hardship withdrawal activity reverted to pre-pandemic levels from 2019, and in 2022, hardship withdrawal activity increased to a new high.”² 

Vanguard reports that 2.8% of participants took a 401(k) hardship withdrawal in 2022, up from 2.1% in 2021.³

Additionally, Vanguard reports that 3.6% of participants took a non-hardship 401(k) withdrawal.⁴

The ability to take a withdrawal from your 401(k) plan may seem appealing – especially if you are facing a financial emergency. 

However, a 401(k) hardship withdrawal may cost you more than you think. 

401(k) Hardship Withdrawals Qualifications

 401(k) Hardship Withdrawals

In order to withdraw from your 401(k), you must be at least 59½ to avoid paying an early withdrawal penalty.

That is unless you qualify for a hardship withdrawal.

The IRS explains, “A hardship distribution is a withdrawal from a participant’s elective deferral account made because of an immediate and heavy financial need, and limited to the amount necessary to satisfy that financial need. The money is taxed to the participant and is not paid back to the borrower’s account.”⁵

However, not just anyone qualifies for a 401(k) hardship withdrawal.

First, your individual 401(k) plan must allow for it, which is likely as Vanguard reports that 95% of plans offer hardship withdrawals.⁶

Next, you must prove you have a financial need that is considered “an immediate and heavy financial need” for any of the following: 

  • Medical care expenses for the employee, the employee’s spouse, dependents or beneficiary.
  • Costs directly related to the purchase of an employee’s principal residence (excluding mortgage payments).
  • Tuition, related educational fees, and room and board expenses for the next 12 months of postsecondary education for the employee or the employee’s spouse, children, dependents, or beneficiary.
  • Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure on the mortgage on that residence.
  • Funeral expenses for the employee, the employee’s spouse, children, dependents, or beneficiary.
  • Certain expenses to repair damage to the employee’s principal residence.⁷

Now that most plans offer hardship withdrawal as an option, it may seem like an easier way to alleviate financial stress.

Given that many Americans are strained financially, it is not too surprising to see an increase in these 401(k) hardship withdrawals.

According to Vanguard, “In 2022, 36% of hardship withdrawals were used to avoid a home foreclosure or eviction, up from 31% of withdrawals in 2021. The second most common reason was medical expenses, as 1 in 3 hardship withdrawals were initiated for this purpose, in line with 2021.”⁸

The Difference between a 401(k) Loan and a 401(k) Hardship Withdrawal

 401(k) Hardship Withdrawals

It’s important to note that we’ve been discussing 401(k) hardship withdrawals and not 401(k) loans.

Both allow plan participants to withdraw money from their 401(k)s, but they work very differently.

A 401(k) loan is meant to be paid back, whereas a 401(k) hardship withdrawal is simply withdrawing money from your retirement savings. And since you are withdrawing money from your retirement savings, you will be taxed on the money withdrawn and face possible penalties. 

In contrast, a 401(k) loan essentially allows participants to borrow from themselves and then pay themselves back with interest, without having to pay penalties or taxes on the amount borrowed as long as it is paid back on time.

While a 401(k) loan might sound like a better way to get the money you need, investors should not rush to take a loan.  

There are downsides that – if you aren’t aware of upfront – could cost you way more than you planned. 

[Related Read: The Downside of 401(k) Loans: Investors Beware]

The Immediate Cost of a 401(k) Hardship Withdrawal

 401(k) Hardship Withdrawals

When facing mounting medical bills or possible foreclosure, it’s tempting to seek a 401(k) hardship withdrawal.

But this money is not actually available immediately.

It can take weeks for the money to leave your 401(k).

If you need cash immediately, a 401(k) hardship withdrawal may not help you. 

It’s also important to understand that, unlike 401(k) loans, you must pay taxes on the amount withdrawn from your 401(k).

Let’s say you take a 401(k) hardship withdrawal because you are cash-strapped, but because of the tax implications, you wind up paying more in the end. 

Moreover, if you take an early 401(k) withdrawal that does not qualify as a “hardship withdrawal,” you may have to pay penalties in addition to taxes. 

The Future Cost of a 401(k) Hardship Withdrawal

 401(k) Hardship Withdrawals

In addition to having to pay taxes and possible penalties in the immediate future, there are costs down the road.

When you withdraw money from your savings, you are left with less savings.

A 401(k) withdrawal is not a loan. You are not paying it back. You are simply taking money away from your retirement.

According to the Center for Retirement Research at Boston College, early withdrawals reduce overall 401(k) assets for retirement by 25% on average.⁹

In addition to paying taxes and possible penalties on the amount, you are also losing out on the power of compound returns.

Research conducted by Employee Benefit Adviser shows, “A hypothetical 30-year-old participant who cashes out a 401(k) savings balance of $5,000 today would forfeit up to $52,000 in earnings the sum would have accrued for them by age 65, if we assume the account would have grown by 7% per annum.”¹⁰

That’s a lot of money you’ll miss out on come retirement. 

A 401(k) Hardship Withdrawal Should Be a Last Resort

 401(k) Hardship Withdrawals

If you are desperate for money, a 401(k) hardship withdrawal should still be your last resort. 

Don’t put your retirement savings at risk.

Instead, consider one of these alternatives:

  • Use HSA savings to cover medical expenses.
  • Consider financing specifically designed for medical needs, such as CareCredit.
  • Tap into other savings accounts, such as emergency savings.
  • Apply for a 0% credit card, pay with it, and then pay it off interest-free before the promotional period ends.
  • Take out a personal loan.
  • Use your home equity line of credit.
  • Ask a family member for a loan. 

Before you make any major financial decisions, especially those involving your retirement savings, it is important to speak with a financial advisor.

Better Prepare for a Life of Abundance in Retirement.
Check us out on YouTube.

Watch Videos

SOURCES

  1. https://business.bofa.com/content/dam/flagship/workplace-benefits/id20_0905/documents/Participant-Pulse.pdf
  2. https://institutional.vanguard.com/content/dam/inst/iig-transformation/has/2023/pdf/has-insights/how-america-saves-report-2023.pdf
  3. https://institutional.vanguard.com/content/dam/inst/iig-transformation/has/2023/pdf/has-insights/how-america-saves-report-2023.pdf
  4. https://institutional.vanguard.com/content/dam/inst/iig-transformation/has/2023/pdf/has-insights/how-america-saves-report-2023.pdf
  5. https://www.irs.gov/retirement-plans/hardships-early-withdrawals-and-loans
  6. https://institutional.vanguard.com/content/dam/inst/iig-transformation/has/2023/pdf/has-insights/how-america-saves-report-2023.pdf
  7. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-hardship-distributions
  8. https://institutional.vanguard.com/content/dam/inst/iig-transformation/has/2023/pdf/has-insights/how-america-saves-report-2023.pdf
  9. http://crr.bc.edu/wp-content/uploads/2015/01/IB_15-2.pdf
  10. https://www.benefitnews.com/advisers/opinion/to-show-participants-you-care-help-them-avoid-401k-cash-outs

 

0 0 votes
Article Rating

401(k) Maneuver™ is offered by Royal Fund Management, LLC, which is registered as an investment adviser with the SEC and only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements. SEC registration does not constitute an endorsement of the firm by the Commission nor does it indicate that the adviser has attained a particular level of skill or ability. Royal Fund Management, LLC, is not affiliated with or endorsed by NASDAQ.

All investment strategies have the potential for profit or loss. Changes in investment strategies, contributions or withdrawals, and economic conditions may materially alter the performance of your portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client's investment portfolio. There are no assurances that a client’s portfolio will match or outperform any particular benchmark. Asset allocation and diversification do not ensure or guarantee better performance and cannot eliminate the risk of investment losses. Projections are based on assumptions that may not come to pass.

Images and photographs are included for the sole purpose of visually enhancing the website. None of them are photographs of current or former clients. They should not be construed as an endorsement or testimonial from any of the persons in the photograph.

All third-party trademarks, including logos and icons, referenced in this website and our content, are the property of their respective owners. Unless otherwise indicated, the use of third-party trademarks herein does not imply or indicate any relationship, sponsorship, or endorsement between 401(k) Maneuver and the owners of those trademarks. Any reference inside this website or content to third-party trademarks is to identify the corresponding third-party goods and/or services.

0
Would love your thoughts, please comment.x
()
x

Select a Date from the Calendar below

UPDATE YOUR 401(k) ACCOUNT

Select a Date from the Calendar below

UPDATE YOUR 401(k) ACCOUNT

Have questions? Need help?

Book Your Complimentary

15-Minute 401(k) Strategy Session


logo

Looking for tips that might maximize your retirement
savings and help you be a better steward of your money?

Subscribe to our 401(k) Blog

The go-to-source for your retirement investing and saving tips

5 401(k) Accounts Mistakes that May Negatively Affect Retirement Income

Download Your Copy Today

*Your privacy is important to us. We do not rent, sell or share your information.


Why Account Balancing & Allocation May Affect 401(k) Performance

Download Your Copy Today


*Your privacy is important to us. We do not rent, sell or share your information.


The 5 Top Costly 401(k) Rollover Pitfalls

Download Your Copy Today

*Your privacy is important to us. We do not rent, sell or share your information.

Make the Best Decision for Retirement:
Understanding the Different Types of
Financial Advisor Licenses

Download Your Copy Today

*Your privacy is important to us. We do not rent, sell or share your information.


How Popular Advice On Target Date Funds May Be
Working To Undermine Your 401(k) Retirement Savings

Download Your Copy Today

*Your privacy is important to us. We do not rent, sell or share your information.


3 Things That May Supercharge Your Future
401K Performance...Even In a Down Economy

Download Your Copy Today

*Your privacy is important to us. We do not rent, sell or share your information.