401(k) Hardship Withdrawals Hit an All-Time High of ‘Worrying’, Says Vanguard

It’s a “worrying” all-time high, said retirement savings and asset management juggernaut Vanguard, offering a view stretching back to 2004.

By comparison, 0.3% of accounts made hardship withdrawals last October and in October 2020 the share was 0.2%, according to Vanguard data. In October 2019, it was 0.4%, he said.

Meanwhile, Vanguard figures showed that 401(k) loans and hassle-free withdrawals are also on the rise. In both cases, 0.9% of 401(K) plan participants requested loans and withdrawals in October.

Fidelity Investments is also seeing a recent increase in hardship withdrawals among the more than 22 million 401(k) plan participants it serves.

Last year, 1.9% of 401(k) participants took a hardship withdrawal, according to Mike Shamrell, vice president of thought leadership. From January to October 2022, the share of people taking hardship withdrawals is 2.2% – this is “still relatively stable” but it is the highest rate since 2020 and inflation is one of the contributing factors, he noted.

It’s easy to guess why more Americans are resorting to 401(k) hardship withdrawals, analysts say. Whether or not the affected economy experiences a spike in inflation, the cost of living remains high. Meanwhile, savings rates are falling and credit card debt is rising.

Equity portfolios also do not offer protection. The Dow Jones Industrial Average DJIA,
+0.25%
is down more than 7% since the start of the year, while the S&P 500 SPX,
+0.68%
fell more than 17% and the tech-heavy Nasdaq Composite COMP
+1.33%
decreased by more than 29%.

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

Tax consequences

That might be an understatement. Some of the tax language, the potential tax consequences, and the very administrative process for making a hardship withdrawal show just how far a household needs to go with the idea.

Holders of 401(k) accounts must show their employer that they have an “immediate and significant financial need” for the money, according to the Internal Revenue Service. This can include expenses such as medical bills, college tuition and funeral costs, the IRS said.

The amount sought should be limited to what is necessary to meet that financial need, the tax agency notes.

Although there is generally a 10% tax penalty for early withdrawals before age 59½, this can be waived but the distribution is still subject to income tax.
Additionally, a person who takes the hardship withdrawal cannot repay it to their 401(k) and they cannot transfer it to another 401(k) plan or an IRA, the tax agency noted.

Household financial pressures are front and center on Capitol Hill. The senses. Cory Booker, a Democrat from New Jersey, and Todd Young, a Republican from Indiana, are hoping to get some traction on a bill that would allow employers to easily create emergency savings accounts for workers, just like they created 401(k) accounts.

Americans’ lack of savings for rainy days creates a scenario in which they will have to turn to their retirement account too often, Orman said at a Tuesday event with Booker and Young.

“We don’t want a situation where people, when they need money, something happens and they need money, they go to their 401(k) or 403(b) or [Thrift Savings Plan] take out a loan,” Orman said. “It’s going to be one of the biggest mistakes they’ve made, but that’s where they’re going for emergency cash.”