401(k) Hardship Withdrawals Are on the Rise as Inflation Keeps Cost of Living at Record Highs

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Persistent high inflation has resulted in a sharp rise in the cost of living for Americans this year, causing more retirement savings account holders to take hardship withdrawals.

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According to two recent studies, 401(k) owners are increasingly borrowing from their future savings to cover hardships such as unexpected medical expenses, a home purchase, post-secondary education or tuition costs, payments to prevent eviction or a foreclosure, funeral expenses or to repair unanticipated damage to a principal residence.

Using data from its 5 million retirement plan participants, investment firm Vanguard found that 0.5% of account owners made hardship withdrawals in October, an all-time high result that was deemed “concerning.” This percentage is up from 0.3% last October and 0.2% in Oct. 2020.

“The recent increase in households drawing on their employer-sponsored retirement accounts, however, could be a sign of some deterioration in the financial health of the U.S. consumer,” said Vanguard’s global head of investor research and policy, Fiona Greig.

Additionally, Fidelity Investments is also seeing an increase in hardship withdrawals among its 22 million 401(k) plan participants, according to a MarketWatch report.

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Per the financial firm’s vice president of thought leadership, Mike Shamrell, 1.9% of the company’s 401(k) owners made a hardship withdrawal in 2021. That number has jumped to the highest rate since 2020, 2.2%, between January and October of this year.

Hardships withdrawals are funds withdrawn from an employer-sponsored retirement plan or IRA to offset an “immediate and heavy financial need,” as defined by the IRS. Most, but not all, retirement plans allow participants to receive hardship distributions. A distribution is limited to the amount necessary to satisfy the financial need being claimed.

However, the IRS warns that withdrawing for hardship poses the following consequences that must be considered:

  • The hardship distribution you receive will permanently reduce the amount you’ll have in the plan at retirement (you cannot “pay back” the hardship amount into your account).
  • The previously untaxed retirement savings you receive as a hardship distribution will be taxed as income.
  • Unless you are aged 59 1/2 or qualify for another of about a dozen IRS exemptions, you may have to pay an additional 10% tax.
  • You may be barred from contributing to your 401(k) for six months after receiving the hardship distribution.
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As Americans continue to struggle to build emergency savings, there could be help coming in the form of legislation. As MarketWatch noted, the Emergency Savings Act of 2022 — co-introduced by Sen. Cory Booker (D-N.J.) and Sen. Todd Young (R-Ind.) — is proposing changes to employee defined contribution plans by adding an emergency savings account option to a sponsored plan.

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Citing a March 2022 Emergency Savings and Financial Security report by the Consumer Financial Protection Bureau, almost 60% of retirement plan holders surveyed — respondents who do not have the financial security of an emergency savings fund — withdrew from their long-term retirement accounts in the past year. Only 9% who had at least a month of emergency savings made withdrawals, by contrast.

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About the Author

David Nadelle is a freelance editor and writer based in Ottawa, Canada. After working in the energy industry for 18 years, he decided to change careers in 2016 and concentrate full-time on all aspects of writing. He recently completed a technical communication diploma and holds previous university degrees in journalism, sociology and criminology. David has covered a wide variety of financial and lifestyle topics for numerous publications and has experience copywriting for the retail industry.
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