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 experienced 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.

At the same time, Vanguard figures show that 401(k) loans and non-difficult withdrawals are also on the rise. In October, 0.9% of 401(k) plan participants had loans and another 0.9% had trouble-free withdrawals.

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

Last year, 1.9% of Fidelity’s 401(k) participants took hardship withdrawals, according to Mike Shamrell, vice president of thought leadership at the company. From January to October 2022, the share of people taking hardship withdrawals was 2.2% – a figure which, although “still relatively stable”, is the highest rate since 2020, and inflation is the 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 is 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,
+2.18%
is down more than 7% since the start of the year, while the S&P 500 SPX,
+3.09%
fell more than 17% and the tech-heavy Nasdaq Composite COMP
+4.41%
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 administrative process required to make a hardship withdrawal show how tough a household has to be to move forward with the idea.

To make a hard withdrawal, a 401(k) account holder must show their employer that they have an “immediate and significant financial need” for the money, according to the Internal Revenue Service. This may be due to expenses such as medical bills, college tuition and funeral costs, the IRS said.

The amount requested should be limited to what is needed to cover that financial need, the tax agency notes.

There is generally a 10% tax penalty for early withdrawals before age 59.5. This fee can be waived for hardship withdrawals, but the distribution is still subject to income tax. Additionally, a person who takes a financial hardship withdrawal cannot repay it on their 401(k) nor can they transfer it to another 401(k) plan or an IRA, the tax agency noted.

The financial pressures facing US households are centered on Capitol Hill. The senses. Cory Booker, Democrat of New Jersey, and Todd Young, Republican of 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 do 401(k) accounts.

America’s shortage of rainy-day savings is creating a scenario where people too often have to turn to their retirement accounts, author and personal finance consultant Suze 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.”