A record high share of Americans are taking emergency hardship withdrawals from their workplace retirement accounts, another sign of stress among workers who are struggling to make ends meet as prices for everyday essentials continue to rise.
Last year, 6% of workers with 401(k) plans administered by Vanguard Group took a hardship withdrawal—up from 4.8% in 2024 and the pre-pandemic average of about 2%, the company reported. The rate of hardship withdrawals is higher than during even the Great Recession.
At the same time, investment balances are up year-over-year, data from Vanguard and fellow financial services company Fidelity shows. So what’s going on?
Well, it’s another datapoint to confirm we’re living in a K-shaped economy, where the fortunes of different classes of Americans are diverging like the legs of the letter K, with the wealthy—high-income earners with investments—faring better and better and represented by that top leg, while everyone else is losing ground, represented by the bottom leg.
@aliciatalksmoney If the economy is as good as politicians say, why don’t you feel it? Blame the K-shaped economy, where the wealthy are doing very well and lower and middle income earners are not. Income inequality didn’t start with Covid, but the pandemic exacerbated things. And now thanks to persistent inflation, higher interest rates, and plenty of other factors, consumer sentiment is dropping and many of us feel worse off financially than we did 5 years ago. #economy #consumer ♬ original sound - Alicia
What to know about hardship withdrawals
Workers are allowed to take a hardship withdrawal from their 401(k) before they reach retirement age if there is “an immediate and heavy financial need,” and the hardship withdrawal is limited to the amount necessary to pay for that need.
Generally, this type of withdrawal is allowed under five different circumstances:
- To pay for medical bills for you, your spouse, or your dependents
- To pay for college tuition, fees, and room and board for you, your spouse, or your dependents
- To avoid foreclosure or eviction
- To pay for funeral expenses
- To pay for certain costs to repair damage to your home
Last year, the top reasons for taking hardship withdrawals were to avoid foreclosure and eviction and to pay medical expenses, according to Vanguard.
That said, there are some other reasons the IRS may waive the 10% early withdrawal penalty. These include:
- You are terminally ill.
- You become disabled.
- You gave birth to a child or adopted a child during the year.
- You used the money to pay an IRS levy.
- You were a victim of a disaster for which the IRS granted relief.
- You over-contributed to a 401(k).
- You were a military reservist called to active duty.
- You have to split up a 401(k) in a divorce.
- You are a domestic abuse survivor.
Financial experts warn against withdrawing money from your retirement accounts as long as you can if you can avoid doing so. Taking money out of your 401(k) means less money invested for your eventual retirement, possibly permanently affecting your future financial security in old age. While you won’t pay a penalty for a hardship withdrawal, you will have to pay taxes at your ordinary income rate. And it could take years to rebuild your balance.
And if you take a withdrawal for any reason other than the five approved above, you’ll also be hit with a 10% early withdrawal penalty if you’re younger than 59½ . Your withdrawal may also be taxed at the state level, depending on where you live.
Of course, it’s easy for financial professionals to advise you to avoid withdrawing funds from your retirement account. When you’re in a financial emergency you might feel like you have no other choice. There are a few other options: Cut spending as much as possible; tap non-retirement assets; look for outside help (like from the government or a private provider); or take out some other type of low-interest loan, like a home equity loan, if you’re able.
A 401(k) loan is another option in some circumstances, and it’s more advisable than a withdrawal because you will have to repay the money, with interest.
“For a small subset of workers facing financial stress, hardship withdrawals may serve as a safety net that may not otherwise have been available,” Vanguard notes in its report.
For those who aren’t in an emergency situation, the best defense is building up a sizable emergency fund, held in cash in a high-interest savings account. Vanguard previously found that those enrolled in a Vanguard-administered 401(k) plan who also had at least $2,000 saved in an emergency fund contributed more to their retirement accounts and took fewer withdrawals while working. For some inspiration on saving money, check out our Home Economics series.
Also important to note: The rules for tapping 401(k)s in an “emergency” were loosened in 2018 and then again in 2022, so that is likely also a factor in why more people are doing so, according to Vanguard. And more employers automatically enrolling their employees in a retirement plan is also a factor, the company says.
