401(k) ‘last resort’ withdrawals climb as experts warn of future hardship

BOSTON — A growing number of Americans are making emergency withdrawals from their 401(k) retirement plans as inflation remains high.

While some 401(k) plans make it possible to take cash out for an emergency, the step comes with consequences.

Nearly 3.6% of workers participating in employer-sponsored 401(k) plans made a so-called ‘hardship’ withdrawal in 2023.

That’s according to one of the largest US retirement plan providers Vanguard, which tracks about 5 million accounts.

The statistic breaks down to about 180,000 of their customers dipping into their savings last year alone.

The Internal Revenue Service allows withdrawals in circumstances of “immediate and heavy financial need.”

This includes events such as flood damage to your home, avoiding eviction, or a substantial medical bill.

“People don’t really plan for the future,” said Virginia Pratt of Jamaica Plain. “A lot of people get to the age of retirement. They suddenly realize, wait a minute, I’ve got to live on half my income and just can’t do it.”

Pratt, who’s a social worker in Boston, told Boston 25 News that she’s trying to work three more years until the age of 70 before she retires.

“Most of us are not stockbrokers. Most of us are not rich,” she said. “People without savings are going to be up a creek basically.”

Boston 25 News spoke with three financial experts in Boston who all shared words of caution about using a 401(k) as a source of emergency funds.

“When you take out an early withdrawal, you’re not only removing that from the retirement plan, but you’re removing all of the future tax-free appreciation,” said Kathleen Sablone, Chief Planning Officer at Boston Financial Management.

Sablone points out the penalty for early distributions is generally 10 percent for those who withdraw before the age of 59 ½, in addition to income taxes you’ll owe.

The taxes you’ll pay depend on your income tax rate.

“You do this now, and you may be jeopardizing your chance to retire,” said Sablone. “In my mind, this is really the last option when you’ve exhausted all other options.”

Some examples, provided by the IRS, where a 10 percent penalty wouldn’t apply include up to $10,000 for first-time homebuyers, total and permanent disability, and unreimbursed medical expenses above 10% of adjusted gross income.

“If you need to pull from it, is it a better resource than a credit card? Probably,” said Alisa Kim O’Neil, Chief Planning Officer at Boston Financial Management.

Kim O’Neil advises people to explore every other option first and try to create a budget for the future.

“You don’t end up getting what you think you’re going to get. The taxes will get you. Is it really worth it?” she questioned.

Before you answer that question, the money you withdraw no longer has the opportunity to grow and compound.

For example, if you left $25,000 in your 401(k) and kept it in your account for another 25 years, that $25,000 would grow to more than $270,000.

That’s if you have an annual return of 10%.

The IRS recently said that people no longer routinely have to provide their employers with documentation proving they need a hardship withdrawal from their 401(k) accounts.

That change allows people to self-certify instead, but there are still some uncertainties in how the IRS would handle audits.

“You could say, I need $1,000 or my house will go into foreclosure, but I’d like to have $1,500 so I can take a trip to the Cape. That’s not going to cut it,” said John Schachter EA with John Schachter + Associates, Inc.

Schachter is a Boston tax consultant who works largely with employers.

He said ultimately the decision to allow hardship withdrawals is with the employers.

“It might be tempting to advocate to your employer that you have an immediate and heavy financial need to get the money, but I would urge an employee to take that seriously,” he said.

Another choice that many 401(k) plans allow is the option to take loans from your account, which you must pay back with interest over time.

You won’t pay income taxes or the 10% penalty if you repay the loan.

“What I’ve always had in mind for my 401K and what I essentially use it for are future-looking things,” said Jonathan Warburg of Back Bay.

Warburg said that strategy allowed him to stop working four years ago.

According to a recent report from the National Institute on Retirement Security, 40% of Gen Xers have zero dollars saved for retirement.

Generation X is made up of people born between 1965 to 1980, and they are the first generation that faces the potential of limited social security.

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