A growing number of individuals with retirement plans are withdrawing savings early. During the last 12 months, 401(k) hardship withdrawals rose by 24%, according to a 2022 study by Empower, a large retirement plan administrator. The funds were used to cover unexpected financial burdens.
Vanguard found that hardship withdrawals hit an all-time high in 2022. The data could indicate signs of declining financial health among Americans. A survey of Vanguard investors found a pessimistic outlook on the stock market’s upcoming short-term performance, with many people anticipating little growth in the market in the coming year.
While some 401(k) plans make it possible to take out cash for an emergency, the step comes with consequences. If your employer provides a retirement plan, it’s worth looking over the details before making a move. The funds could help you get through a financial struggle. However, you might lose out on ways to save for the long-term.
Given the recent uptick in 401(k) hardship withdrawals, it can be helpful to:
- Review the reasons behind the hardship withdrawal.
- Understand the latest rules that allow you to take out cash.
- Look at the long-term consequences of a hardship withdrawal.
- Know the penalties and costs involved.
Why 401(k) Hardship Withdrawals Have Increased
With inflation hitting a 40-year high, consumers are finding it more expensive to maintain their current lifestyle. “Many people cannot keep up with the costs of living,” says Mark Kinsella, a financial planner at Family Financial Planning Services in Wheaton, Illinois. “The retirement plan may be the only cushion available.”
Another reason for the higher number of withdrawals could be related to health. “One’s health insurance may not cover a particular health issue,” Kinsella says. If you or someone in your family needs treatment or a major surgery, you might tap into retirement funds to help. Emergencies such as a job loss or a natural disaster could also lead account owners to access funds early.
The Latest Rules About Hardship Withdrawals
Not all employers allow for hardship withdrawals. For those that do permit contributors to withdraw funds, “there are certain requirements that must be met,” says Kevin Chancellor, a financial planner and founder of Black Lab Financial Services in Melbourne, Florida. You could be eligible for a hardship withdrawal for:
- Funds to purchase a principal residence.
- High medical expenses.
- Qualifying tuition and education-related fees.
- Preventative measures to avoid a foreclosure or home eviction.
- Burial or funeral expenses that qualify.
- Disaster-related repairs.
Under the new rules related to the SECURE 2.0 Act of 2022, employees may state they had emergency expenses that merit a hardship withdrawal. Beginning in 2024, they can take up to $1,000 per year for emergency expenses without incurring the usual 10% early withdrawal penalty. Account owners have the option to repay the distribution within three years, and may not have to pay taxes on the amount that is put back in the account. The account will need to be repaid before additional funds can be withdrawn.
“Hardship withdrawals from 401(k) plans can make sense at times, but only after all other options have been exhausted,” says William J. Procasky, an assistant professor of finance at Texas A&M University—Kingsville.
What a Hardship Withdrawal Means Financially
The IRS lists guidelines for hardship withdrawals that indicate the participant must have “an immediate and heavy financial need.” The amount taken from the plan is used to cover the expense, and it cannot exceed the hardship cost. In addition, plan participants are required to show that they are unable to pay for the financial need with other resources.
The long-term impact could mean a loss of tens of thousands of dollars. “Taking $30,000 for a hardship withdrawal could cost you over $100,000 over the course of your working career,” Chancellor says. “Planning early and building an adequate emergency fund can not only save you from a hardship, but also indirectly help your retirement.”
Hardship Withdrawal Penalties and Fees
When a hardship withdrawal is taken, taxes will need to be paid on the amount. If you are in the 22% income tax bracket and withdraw $10,000, it will qualify as income. In some cases, you will have to pay a 10% withdrawal fee if you are not yet 59 1/2 years old. If you pay 32% on the $10,000 withdrawal, you will net only $6,800. If you need the full $10,000, you might have to withdraw $14,706 to receive enough usable funds.
In some cases, an employer might allow a retirement plan loan. This option could help you avoid paying taxes and penalties on the amount withdrawn. “Generally, the interest rate on the loan would be reasonable,” Kinsella says. “Repayments of the loan would be deposited back into the employee’s work retirement plan.” The setup allows you to reimburse the account over time. After repaying the loan, you might not have as much as you did before you took out the funds, but you will likely have more than if you merely took a withdrawal.
Source link
